a proven year... a solution for healthcare >>>
2002 annual report This year’s annual report is dedicated to Howard E. Cox, Jr., a member of our board of directors from 1993 to 2003, whose support, confidence and perseverance helped the company to reach where it is today.
Centene will be a recognized market leader in government-supported, physician-driven healthcare, creating enhancedmission value through positive outcomes for our members and clients.
Annual Report History FINANCIAL HIGHLIGHTS Year ended December 31, (in thousands, except membership and per share data)
1998 1999 2000 2001 2002
Membership 135,600 142,300 194,200 235,100 409,600
Revenue $150,438 $201,429 $221,350 $326,569 $461,487
Earnings from operations $ (6,827) $ (6,612) $ 6,520 $ 18,472 $ 31,606
EPS $ (6.78) $ (10.99) $ 1.13 $ 1.61 $ 2.20
>>> 1 DEAR SHAREHOLDERS,
AT CENTENE, OUR CORE BELIEF HAS ALWAYS BEEN THAT EVERY AMERICAN IS ENTITLED
TO RECEIVE QUALITY HEALTHCARE WITH DIGNITY. AS SUCH, OUR HEALTH PLANS AND CARE COORDINATIONdelivering PROGRAMS SPECIFICALLY TARGET THE MEDICAID POPULATION, WHICH HISTORICALLY HAS BEEN UNDERSERVED. WE BELIEVE THAT OUR FOCUSED APPROACH
WILL ENABLE US TO ACHIEVE STEADY GROWTH WHILE GENERATING STABLE MARGINS.
In today’s difficult economic climate, we remain the solution for the states, working successfully to save them money and “enabling better health outcomes for their Medicaid recipients.”
The year 2002 was further proof that the man- healthcare an entitlement that every American aged Medicaid model works. During our first has a right to receive with dignity. We believe full year operating as a public company, we that healthcare is most successfully delivered achieved our internal goals of strong financial where it may best be measured—in the local performance. This was accomplished by solid marketplace. Therefore, we distinguish our- organic growth and execution of our stated selves through our local approach, which acquisition strategy, highlighted by our entry encompasses local branding, locally managed into New Jersey. We did this while accomplish- call centers and strong relationships with ing our mission of saving states money while physicians, holding them accountable for the improving health outcomes with quality care quality of care delivered. for our recipients. At Centene, we consider We are focused on managed Medicaid and of recipients into managed Medicaid programs Medicaid-related products. The three key delivers higher quality of care and is more cost populations served include Temporary effective than using fee-for-service care. We Assistance for Needy Families (TANF) and choose to operate only in mandated Medicaid State Children’s Health Insurance Programs states, which we believe are more fiscally (SCHIP), which are characterized by a pre- responsible and offer the most substantial dominance of women and children, and opportunities for working constructively with Supplemental Security Income (SSI), designed the industry. Importantly, whether operating to help the aged, blind and disabled. in prosperous or difficult economic times, Centene continues to be the solution for states The Medicaid managed care industry remains seeking to manage their fiscal budgets. very attractive to us. It is estimated by the Centers for Medicare and Medicaid Services Two noteworthy studies conducted by Milliman (CMS) that this industry will grow substan- USA and the Urban Institute Health Policy tially, from $225 billion today to over $444 Center concretely point to the ongoing savings billion by 2010. We are poised to take advantage states are able to realize by enrolling recipients of this opportunity by adding new member in managed Medicaid programs. The Milliman lives into our programs while reducing exces- USA study, conducted in Wisconsin in 2001, sive spending and being interdictive in the demonstrated that the managed Medicaid management of care. industry estimated saving the state $56 million in 2002, an increase of 45% over 2001. We recognize that states have budget issues, According to state data, savings in 2002 in and regard this as an opportunity to construc- Texas and New Jersey are both estimated at tively restructure the allocation of benefits to $30 million, and savings are estimated at $9 maximize the number of people whose care million in Indiana, each of which represents these basic benefits cover. We support the fed- an improvement over 2001 levels. Beginning eral alternative to give states more flexibility in 2003, we will provide report cards to our in managing their social services budgets. states, measuring our performance and the fiscal Centene is a company that has successfully benefits of working with Centene. We will con- worked through turbulent times in the past tinue to work proactively and responsibly with with the states, only to emerge stronger. We the states in which we operate to ensure ongoing fundamentally believe the states in which we cost savings and convey the benefits of enrolling operate realize that the continued enrollment recipients in managed Medicaid programs.
>>> 3 We are proud of the progress we made during remains predictable and profitable. Through the last year in bringing new recipients into our the combination of emergency room policy programs. We closed 2002 with 409,600 lives, changes, aimed at reducing inappropriate uti- an annual increase of 74% that we achieved lization and frequent visits to the ER, and rate through a combination of record unit member- increases of a blended 5.1% across all of ship growth and important acquisitions and our states in 2002, we believe that we have alliances. These transactions not only expanded developed the standard for a business model our positions in existing markets, but gave us a that works. presence in new markets. In September we acquired 24,000 SCHIP lives in Texas, increasing Other important milestones marked 2002. We our market positions in San Antonio and El Paso concluded a successful secondary offering of while entering two new service areas, Amarillo 5.75 million shares, enabling our venture capi- and Lubbock. We entered our fourth state, tal investors to sell shares in an orderly fashion New Jersey, through a joint venture with the and increasing the trading liquidity of our University of Medicine and Dentistry of New stock. Additional noteworthy events included Jersey (UMDNJ), adding approximately 52,000 the expansion of our claims processing facility Medicaid members in 15 counties throughout and significant new management appointments, the state. With 685,000 Medicaid participating both aimed to accommodate organic and lives in this market, we anticipate future acquisition-driven membership growth; and organic growth in New Jersey. the purchase of Bankers Reserve Life Insurance of Wisconsin to sell reinsurance solely to our At Centene, we measure our success using a health plan subsidiaries. We will use this entity number of metrics. For example, we work dili- to consolidate the risk of our health plans, gently to maintain our physicians’ satisfaction thereby allowing us to provide improved levels by being sensitive to the timely payment and of insurance without changing the overall risk processing of claims. The number of days in profile of our consolidated operations. This claims payable on hand continued to decline enables us to reduce our reinsurance costs and in 2002 to 71.8 days from 73.4 days a year ago, receive recognition for such in the state in proof of our efficient management of the claims which we operate. payment process. Another way that we ensure access to and quality of care is by carefully We were very proud of our 2002 results, high- monitoring complaint ratios regarding our lighted by a 41.3% increase in revenue to $461.5 services to providers and patients. Further- million and fully diluted earnings per share more, our margin protection programs are of $2.20, an increase of 36.6%. These metrics, critical to ensuring that our business model in combination with a solid increase in membership marked our 14th consecutive Medicaid-related products. The behavioral quarter of growth. Operating cash flow health arena is a good example. Today, 6% of remained strong at $39.7 million, an increase all ambulatory care is behavioral health related of 31.4%. We are pleased to report that our and, therefore, the potential to affect this cost health benefits ratio (HBR) continued to center and manage the care of this patient improve and remains within our targeted group is significant. We look forward to banded range of 82.0% to 83.5% of revenues. updating you on our progress in this area in Our SG&A showed sustained decreases; mov- due course. ing toward our goal to have our SG&A ratio in single digits by the fourth quarter of 2003. The At Centene, our approach is to achieve pre- balance sheet remains healthy with $164.7 dictable and consistent results. In 2002, we million in cash and investments and no debt. accomplished those goals and, we believe that Finally, we continued to build the required we have the winning formula for continued infrastructure to enhance our information success in the managed Medicaid industry. Our systems platform, which has the capacity to solid financial performance along with a care- handle in excess of 1 million lives. fully planned growth strategy provide a solid foundation for continued strong performance. As we enter 2003, we will continue to work with our states to deliver cost-effective, quality Our achievements would not be possible with- healthcare and will remain focused on the out the dedication and hard work of all the opportunities that exist in mandatory states. employees at Centene. I would personally like There are 37 mandatory states, 25 of which are to thank them for their ongoing commitments of interest to us. We have a full pipeline of and contributions. acquisition targets and will continue to be dis- >>> ciplined, prudent purchasers, focusing on Sincerely, accretive opportunities. We delivered on our predictability for promise to enter a new state in 2002 and expect to continue to target attractive market opportu- nities. Concurrent with this aggressive acquisi- the future tion program, we will strengthen staffing to further accelerate our efforts. MICHAEL F. NEIDORFF President and Chief Executive Officer
In addition, we will evaluate opportunities to diversify our revenue base and expand our product offering, particularly in fee-for-service
>>> 5 TEAMWORK
AT CENTENE, OUR UNIFIED LEADERSHIP TEAM IS COMMITTED TO DELIVERING BETTER HEALTHCARE FOR OUR CONSTITUENCY. WEleadership FIRMLY BELIEVE THAT QUALITY HEALTHCARE IS AN AMERICAN ENTITLEMENT AND HAVE SUCCESSFULLY BUILT OUR BUSINESS ON DELIVERING THAT PROMISE.
Our successes have been predicated on remaining predictable Jesse N. Hunter—Given that one of Centene’s key goals is to the people to whom we are accountable, which includes to diversify the business and increase market share, we hired our providers, members, states, employees and shareholders. Jesse Hunter as our Manager of Mergers and Acquisitions. We believe that Jesse’s solid background in building man- Our commitment to the advancement of employees from aged care partnerships and collaborations will be a great within was highlighted this year by several noteworthy pro- asset to the company. motions. Carol Goldman was promoted from her position as Director of Human Resources (Plans) and is now Vice Daniel R. Paquin—As part of our effort to manage the inte- President and Chief Administrative Officer; Cary Hobbs was gration of newly acquired plans and organize start-up oper- promoted from Director of Business Implementation to ations in new markets, we appointed Daniel Paquin as Senior Vice President of Strategy and Business Implementation; Jim Vice President of our Health Plan Business Group. Dan has Reh was Director of IT & Facilities and is now Vice President extensive experience in the development and management of Facilities Management; Cindy Jansky, formerly Director of of Medicaid plans across diverse markets, including New Human Resources, is now Vice President of Human Resources; Jersey, our newest market. and Judy Bauer was promoted from Director of Medical Management to Vice President of Care Management. John D. Tadich—In addition to evaluating new market opportunities for diversification and expansion, we are also In addition to recognizing talent within our organization, looking to broaden our service offerings in Medicaid and we seek the best in the industry to join Centene. To execute Medicaid-related products such as behavioral health and our growth strategy, we have significantly strengthened the NurseWiseSM. To this end, we hired John Tadich, a 25-year management team with the addition of several highly quali- veteran of the managed care industry with a focus in spe- fied and experienced senior managed care executives. cialty companies, to the newly created position of Senior Vice President of Specialty Companies. Christopher Bowers—Since entering the Texas market two years ago, we have achieved significant membership growth. We are pleased to have these quality individuals on our To support this growth, Christopher Bowers was appointed as team. As we grow, we will seek further opportunities to President and Chief Executive Officer of Superior HealthPlan build and retain our leadership team. in Texas. We expect that Chris’ expertise in managing Medicaid managed care operations and government pro- grams will help us to attain this important goal. >>> solution for the recipients
>>> 7 >>> solution for the local communities LOCAL RECOGNITION
OUR “LOCAL APPROACH” DISTINGUISHES CENTENE IN ITS MARKETS. BY PROVIDING ACCESS TO OUR HEALTHCARE SERVICES THROUGHcommitment A LOCAL NETWORK OF PHYSICIANS WHO UNDERSTAND THE CULTURAL NORMS OF THEIR COMMUNITIES, WE HAVE ACHIEVED A HIGH DEGREE OF SUCCESS IN OUR SERVICE AREAS.
While Centene is a national company, we firmly believe that of the cumbersome policies that are not conducive to healthcare is local, touching regulators, healthcare providers, better outcomes. government officials and patients. To maximize awareness in each of our markets, we operate our health plans under We support our local health plan operations with central- brand names unique to each market and have developed ized finance, information, claims and medical management and maintain a number of widely recognized and highly support systems. This enables us to achieve greater utiliza- visible local programs. For example, we use local call centers tion and cost controls that have lead to continuously for member and provider relations. Our goal is to be indige- improved outcomes. nous to the markets in which we operate and embraced as the hometown solution. We believe that our obligation is to be a low cost provider, establishing reasonable plan and administrative margins in Central to our approach is our network of physicians who order to maintain appropriate financial viability for the states establish local policies and practices in our markets. This in which we operate. One key measurement of our commit- serves to build recognition of Centene’s health services ment to maximizing benefits to our recipients while keeping within each of our respective markets. These physicians have healthcare costs down and improving the quality of services significant representation on our local boards of directors provided is our health benefits ratio, which we maintain in and, through organized committees, drive how healthcare is a targeted range of 82.0% to 83.5% for the SCHIP and TANF provided in their communities. Furthermore, we developed business. For the year ended December 31, 2002, our health these committees, which are led by our physician members, benefits ratio was 82.3%. to review physician credentials, quality management pro- grams, utilization review policies and physician compensa- The end of 2002 marked our eighth consecutive quarter of tion programs and policies. declining SG&A ratio, from 13.7% in the fourth quarter of 2000 to 10.8% in the fourth quarter of 2002. Importantly, As a result of their active involvement in developing we calculate this ratio conservatively and do not include and implementing our healthcare delivery policies, the interest income in the revenue line. We believe that our highly physicians are committed and loyal to Centene. We recog- scaleable platform gives us the ability to rapidly expand nize the importance of protecting provider cash flow membership at a relatively low incremental cost. Our goal and consistently pay claims with one of the best records in is to achieve a single digit SG&A ratio by the fourth quarter the industry. We will continue to strengthen these relation- of 2003 for our current TANF and SCHIP population. ships through continued timely payments and reduction
>>> 9 PREDICTABILITY
OUR YEAR-END RESULTS REAFFIRM THE CONSISTENCY, PREDICTABILITY AND SUSTAINABILITY OF THE CENTENE BUSINESS MODEL. WE REMAIN TRUE TO OUR resultsFOCUS OF BEING A PREDICTABLE COMPANY DELIVERING ON ITS PROMISES AND STATED EXPECTATIONS.
Period-End Membership One year following our which are served by University Health Plans, Inc. and sim- (in thousands) initial public offering, we ilar prospects exist in our three other states to capture addi- are proud to say that we are tional unit growth. Additionally, we will continue to make successfully fulfilling our prudent and disciplined acquisitions based upon strict crite- 409.6 mission to deliver better ria and focus on markets where we believe Centene can be healthcare to our recipients the market leader in its contracted service area. while providing the solu- 235.1
194.2 tion for states to manage We believe that part of predictability is accountability. This 142.3 135.6
97.5 their Medicaid costs. year, we will be issuing each of our states a report card giv- ’97 ’98 ’99 ’00 ’01 ’02 ing both qualitative and quantitative assessments of our We remain committed to performance. This will include matrices focused on quality- the execution of our threefold strategy: 1) to evaluate new of-care and efficiency of claims payments as well as data on market opportunities for diversification and expansion of the cost savings over traditional fee-for-service in the our business, 2) to grow organically and 3) to pursue Medicaid population. Importantly, third parties will com- opportunities in Medicaid and Medicaid-related products pile this data, increasing the objectivity and credibility such as behavioral health and NurseWise.SM of the matrices and their conclusions. We believe this increased accountability will help us deliver even better There are significant organic growth opportunities in our results going forward. current markets. In our New Jersey market, for example, there are approximately 685,000 Medicaid lives, 52,000 of >>> solution for delivering care
>>> 11 >>> solution for promoting wellness OUTREACH
WE ARE A MEDICAID MANAGED CARE COMPANY, ENCOMPASSING THREE KEY POPULATIONS: TEMPORARY
ASSISTANCE FOR NEEDY FAMILIES (TANF), SUPPLEMENTAL SECURITY INCOME (SSI) AND STATE CHILDREN’S HEALTH
INSURANCE PROGRAMSinteraction (SCHIP). OUR FOCUSED BUSINESS MODEL ENABLES US TO OFFER PROGRAMS THAT MEET
THE SPECIFIC NEEDS OF THESE POPULATIONS.
Medicaid provides medical benefits and health services complications) and a number of disease management pro- to low-income families and people with disabilities. It grams designed to help educate our members on medical is distinct in that the majority of participants are women conditions such as asthma, diabetes and pregnancy. The and children with fewer chronic conditions. As a result, objectives of these outreach programs are to educate the majority of Centene’s programs and services emphasize members on how to access primary care and reduce inap- family-focused care, namely obstetrics/gynecology, pedi- propriate and expensive emergency room visits, thereby atrics and internal medicine. improving overall health outcomes and reducing costs. Initially developed to promote wellness, these programs We continuously refine and expand our key programs as have become additional sources of revenue for Centene. our membership grows. These include NurseWiseSM (a toll- free phone line that our members may call for nurse assis- Consistent with our strategy of becoming a multi-line tance when they cannot reach a doctor), CONNECTIONS Medicaid services company, we plan to expand into the (an education and outreach program designed to provide behavioral health area, an underserved area in Medicaid- our members with the medical information required in related products. We view this as a natural extension of our promoting preventative care), STARTSMART for Your BabySM business, particularly since there is significant overlap (a telephone-based pre-natal and infant health program among patient groups, and we believe that there are definite designed to improve access to pre-natal care and reduce birth synergies with our current programs.
>>> 13 Centene Corporation and Subsidiaries
TABLE OF CONTENTS
Quarterly Selected Financial Information >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 15
Selected Financial Information >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 16
Management’s Discussion and Analysis of Financial
Condition and Results of Operations >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 17
Quantitative and Qualitative Disclosures
About Market Risk >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 31
Consolidated Balance Sheets >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 32
Consolidated Statements of Earnings >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 33
Consolidated Statements of Stockholders’ Equity >>>>>>>>>>>>>>>>>>>>page 34
Consolidated Statements of Cash Flows >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 36
Notes to Consolidated Financial Statements >>>>>>>>>>>>>>>>>>>>>>>>>>>>page 37
Certifications >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 51
Report of Independent Accountants >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 53
Report of Independent Public Accountants >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>page 54 Centene Corporation and Subsidiaries
QUARTERLY SELECTED FINANCIAL INFORMATION In thousands, except share data and membership data / unaudited
For the Quarter Ended March 31, June 30, September 30, December 31, 2001 2001 2001 2001 Total revenues $70,304 $ 80,560 $ 85,414 $ 90,291 Earnings from operations 2,906 4,513 5,355 5,698 Earnings before income taxes 3,777 5,343 6,175 6,731 Net earnings $ 2,182 $ 3,230 $ 3,563 $ 3,920 Net earnings attributable to common stockholders $ 2,059 $ 3,107 $ 3,440 $ 3,822 Per share data: Earnings per common share, basic $ 2.27 $ 3.41 $ 3.78 $ 1.37 Earnings per common share, diluted $ 0.29 $ 0.42 $ 0.45 $ 0.45 Period end membership 205,000 213,200 224,800 235,100
For the Quarter Ended March 31, June 30, September 30, December 31, 2002 2002 2002 2002 Total revenues $95,753 $107,610 $116,398 $141,726 Earnings from operations 6,262 7,718 8,028 9,598 Earnings before income taxes 7,177 8,683 14,780 10,496 Net earnings $ 4,300 $ 5,234 $ 9,273 $ 6,814 Per share data: Earnings per common share, basic $ 0.43 $ 0.51 $ 0.87 $ 0.63 Earnings per common share, diluted $ 0.38 $ 0.45 $ 0.78 $ 0.57 Period end membership 249,300 278,600 296,100 409,600
>>> 15 Centene Corporation and Subsidiaries
SELECTED FINANCIAL INFORMATION
Year Ended December 31, 2002 2001 2000 1999 1998
(In thousands, except share data) Statement of Earnings Data: Revenues: Premiums $461,030 $326,184 $216,414 $200,549 $149,577 Administrative services fees 457 385 4,936 880 861 Total revenues 461,487 326,569 221,350 201,429 150,438 Operating expenses: Medical services costs 379,468 270,151 182,495 178,285 132,199 General and administrative expenses 50,413 37,946 32,335 29,756 25,066 Total operating expenses 429,881 308,097 214,830 208,041 157,265 Earnings (losses) from operations 31,606 18,472 6,520 (6,612) (6,827) Other income (expense): Investment and other income, net 9,575 3,916 1,784 1,623 1,794 Interest expense (45) (362) (611) (498) (771) Equity in earnings (losses) from joint ventures — — (508) 3 (477) Earnings (losses) from continuing operations before income taxes 41,136 22,026 7,185 (5,484) (6,281) Income tax expense (benefit) 15,631 9,131 (543) — (1,542) Minority interest 116 ———— Earnings (losses) from continuing operations 25,621 12,895 7,728 (5,484) (4,739) Loss from discontinued operations, net — — — (3,927) (2,223) Net earnings (losses) 25,621 12,895 7,728 (9,411) (6,962) Accretion of redeemable preferred stock — (467) (492) (492) (122) Net earnings (losses) attributable to common stockholders $ 25,621 $ 12,428 $ 7,236 $ (9,903) $ (7,084) Net earnings (losses) from continuing operations per common share: Basic $2.45 $ 8.97 $ 8.03 $ (6.63) $ (4.65) Diluted $ 2.20 $ 1.61 $ 1.13 $ (6.63) $ (4.65) Net earnings (losses) per common share: Basic $2.45 $ 8.97 $ 8.03 $ (10.99) $ (6.78) Diluted $ 2.20 $ 1.61 $ 1.13 $ (10.99) $ (6.78) Weighted average common shares outstanding: Basic 10,477,360 1,385,399 901,526 900,944 1,044,434 Diluted 11,644,077 8,019,497 6,819,595 900,944 1,044,434 Pro forma net earnings per common share: Basic $ 1.38 $ .52 Diluted $ 1.25 $ .52 Pro forma weighted average common shares outstanding: Basic 10,049,085 10,025,885 Diluted 11,100,319 10,069,595
At December 31, 2002 2001 2000 1999 1998
(In thousands) Balance Sheet Data: Cash, cash equivalents and short-term investments $ 69,227 $ 90,036 $ 26,423 $ 23,663 $ 21,525 Total assets 210,327 131,366 66,017 52,207 45,727 Long-term debt, net of current portion — — 4,000 4,000 4,000 Redeemable convertible preferred stock — — 18,878 18,386 17,700 Total stockholders’ equity (deficit) 102,183 64,089 (8,834) (16,367) (6,196) Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview member per month pursuant to our state contracts. We We provide managed care programs and related services generally receive premiums during the month we provide to individuals receiving benefits under Medicaid, including services and recognize premium revenue during the period Supplemental Security Income, or SSI, and the State in which we are obligated to provide services to our members. Children’s Health Insurance Program, or SCHIP. We have We also generate administrative services fees for providing health plans in Wisconsin, Texas, Indiana and New Jersey. services to SSI members on a non-risk basis.
On December 1, 2002, we acquired 80% of the outstanding Premiums collected in advance are recorded as unearned capital stock of University Health Plans, or UHP, from premiums. Premiums due to us are recorded as premium University of Medicine and Dentistry of New Jersey, or and related receivables and are recorded net of an allowance UMDNJ, which continues to own the remaining capital based on historical trends and our management’s judgment stock of UHP. UHP is a managed health plan operating in on the collectibility of these accounts. As we generally 15 counties in New Jersey. We paid an aggregate purchase receive premiums during the month in which services are price of approximately $10.6 million for our interest in provided, the allowance is typically not significant in com- UHP. We entered into an investor rights agreement with parison to total premium revenue and does not have a UMDNJ providing that, among other things: material impact on the presentation of our financial condi- tion, changes in financial position or results of operations. • We have the right, exercisable at any time prior to From 1998 to 2000, however, we provided Medicaid serv- September 1, 2003, to purchase the remaining shares ices in certain regions of Indiana as a subcontractor of UHP held by UMDNJ for a cash purchase price of with Maxicare Indiana, Inc. In June 2001, the Insurance $2.6 million. Commissioner of the Indiana Department of Insurance declared Maxicare insolvent and ordered Maxicare into liq- • If we do not exercise the right described above, the remain- uidation. As a result, we recorded an allowance for uncol- ing shares of UHP held by UMDNJ will be exchanged on lectible receivables in the amount of $2.7 million to fully December 1, 2005 for a purchase price payable in either, at reserve for all receivables from Maxicare as of December 31, our election, shares of our common stock or cash. The 2001. In 2002, subsequent to a release and settlement agree- purchase price would equal the greater of (a) $2.6 million ment with Maxicare and the Indiana Insurance Com- or (b) the product of (1) the enterprise value of UHP as of missioner which requires no payment by either Maxicare or December 1, 2005 and (2) the percentage of the out- us, we wrote off the entire balance of the receivable from standing UHP common stock (on a fully diluted basis) Maxicare as uncollectible and reduced the related allowance then represented by the shares owned by UMDNJ. for doubtful accounts.
In June 2002, Superior HealthPlan entered into an agree- The primary driver of our increasing revenues has been ment with Texas Universities Health Plan Inc. to purchase membership growth. We have increased our membership the SCHIP contracts in three Texas service areas. Effective through both internal growth and acquisitions. From September 1, October 1 and November 1, 2002, the state of December 31, 2000 to December 31, 2002, we increased Texas approved the contract sales between Superior and our membership by 111%. The following table sets forth Texas Universities Health Plan, thereby adding approxi- our membership by state: mately 24,000 members to our Texas health plan. As a result December 31, of this transaction, $595 was recorded as an intangible asset, purchased contract rights. We are amortizing the 2002 2001 2000 contract rights on a straight-line basis over five years, the Wisconsin 133,000 114,300 60,200 period expected to be benefited. Texas 118,000 54,900 26,000 Indiana 105,700 65,900 108,000 Revenues New Jersey 52,900 —— We generate revenues primarily from premiums we receive Total 409,600 235,100 194,200 from the states in which we operate to provide health benefits to our members. We receive a fixed premium per
>>> 17 Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
The following table sets forth our membership by line of to cover uncertainties related to fluctuations in physician business: billing patterns, membership, products and inpatient hospital trends. These estimates are adjusted as more infor- December 31, mation becomes available. We utilize the services of consult- 2002 2001 2000 ants who are contracted to review our estimates quarterly. Medicaid (excluding SSI) 336,100 210,900 183,500 While we believe that our process for estimating IBNR is SCHIP 65,900 21,800 9,800 actuarially sound, we cannot assure you that healthcare SSI 7,600 2,400 900 claim costs will not exceed our estimates. Total 409,600 235,100 194,200 Our results of operations depend on our ability to manage In 2002, our membership increased by 24,000 members expenses related to health benefits and to predict accurately in Texas due to the purchase of SCHIP contract rights from costs incurred. The table below depicts our health benefits Texas University Health Plan. In addition, two smaller plans ratio, which represents medical services costs as a percentage exited the Austin, Texas market. As a result, our Texas plan of premium revenues and reflects the direct relationship increased its membership by 28,000 lives. This increase between the premium received and the medical services pro- includes 12,000 lives that we are managing for the state of vided. Our stabilization in the ratio primarily reflects Texas on an interim basis and that will become part of a improved provider contract terms, premium rate increases reprocurement process scheduled for mid 2003. We entered in our markets served and member reductions in our south- the New Jersey market through our acquisition of 80% of the ern Indiana market. equity of UHP. Membership increases in our Wisconsin and Year Ended December 31, Indiana markets resulted from additions to our provider net- 2002 2001 2000 work and growth in the number of Medicaid beneficiaries. Health benefits ratio 82.3% 82.8% 84.3% In 2001, our membership in Indiana declined due to a sub- contracting provider organization terminating a percent-of- Our general and administrative expenses primarily reflect premium arrangement, which was our only contract of that wages and benefits and other administrative costs related type. Separately, we entered into agreements with Humana to our employee base, including those fees incurred to pro- that resulted in the transfer to us of 35,000 members in vide services to our members. Some of these services are Wisconsin and 30,000 members in Texas. provided locally, while others are delivered to our health plans from a centralized location. This approach provides In 2000, a competitor in our Wisconsin market terminated the opportunity to control both direct and indirect costs. its participation in the Medicaid program benefiting our The major centralized functions are claims processing, enrollment growth. Our membership growth in the northern information systems, finance, medical management support and central regions of Indiana was offset by our decision to and administration. The following table sets forth the gen- reduce our participation in the southern region. Our El Paso eral and administrative expense ratio, which represents health plan achieved sizable growth because we were named general and administrative expenses as a percent of total the default health plan in this area and enrolled a majority revenues and reflects the relationship between revenues of the members who failed to select a specific plan. earned and the costs necessary to drive those revenues. Year Ended December 31, Operating Expenses Our operating expenses include medical services costs and 2002 2001 2000 general and administrative expenses. General and administrative expenses ratio 10.9% 11.6% 14.6% Our medical services costs include payments to physicians, hospitals, and other providers for healthcare and specialty The improvement in the general and administrative product claims. Medical service costs also include estimates expenses ratio reflects growth in membership and leverag- of medical expenses incurred but not yet reported, or IBNR. ing of our overall infrastructure. For example, the decrease in Monthly, we estimate our IBNR based on a number of fac- our general and administrative ratio over the past two years tors, including inpatient hospital utilization data and prior in part reflects our efforts to increase claims processing claims experience. As part of this review, we also consider efficiencies through our centralized support functions. As a the costs to process medical claims and estimates of amounts result, our days in claims payable, which is a calculation of Centene Corporation and Subsidiaries
medical claims liabilities at the end of the quarter divided Medical Claims Liabilities by average claims expense per calendar day for such quarter, Our medical services costs include estimates for claims decreased from 73.4 days at December 31, 2001 to 71.8 at received but not yet adjudicated, estimates for claims December 31, 2002. Net of the effects of our acquisition of incurred but not yet received and estimates for the costs nec- 80% of the capital stock of UHP on December 1, 2002, our essary to process unpaid claims. We, together with our inde- days in claims payable at December 31, 2002 would have pendent actuaries, estimate medical claims liabilities using been 64.5 days. actuarial methods based upon historical data for payment patterns, cost trends, product mix, seasonality, utilization of Other Income (Expense) healthcare services and other relevant factors. These esti- Other income (expense) consists principally of investment mates are continually reviewed and adjustments, if necessary, and other income, interest expense and equity in earnings are reflected in the period known. (losses) from joint ventures. In applying this policy, our management uses its judgment • Investment income is derived from our cash, cash to determine the assumptions to be used in the determination equivalents and investments. Information about our of the required estimates. While we believe these estimates investments is presented below under “Liquidity and are appropriate, it is possible future events could require us Capital Resources.” to make significant adjustments for revisions to these esti- mates. The estimates are based on our historical experience, • Interest expense reported in 2002 represents commitment terms of existing contracts, our observance of trends in the fees paid to a bank in conjunction with our undrawn industry, information provided by our customers and infor- credit facility. Interest expense reported in 2001 and 2000 mation available from other outside sources, as appropriate. primarily reflected interest paid on our subordinated notes, which we repaid in full in December 2001. The change in medical claims liabilities is summarized as • Equity in earnings (losses) from joint ventures principally follows: represented our share of operating results from Superior HealthPlan, which we formed with Community Health 2002 2001 2000 Centers Network in 1997. From 1998 through 2000, we Balance, January 1 $ 59,565 $ 45,805 $ 37,339 owned 39% of Superior, and therefore accounted for the Acquisitions 16,230 5,074 — investment under the equity method of accounting. Incurred related to: Effective January 1, 2001, we entered into an agreement to Current year 399,141 289,133 188,034 purchase an additional 51% of Superior. We also agreed Prior years (19,673) (18,982) (5,539) to purchase from TACHC GP, Inc. a term note pursuant to which Superior owed TACHC $160,000. As a result of Total incurred 379,468 270,151 182,495 entering into this agreement, we began accounting for our Paid related to: investment in Superior using consolidation accounting. Current year 326,636 230,216 146,360 We therefore no longer reflect any operations of Superior Prior years 37,446 31,249 27,669 in equity in earnings (losses) from joint ventures and we Total paid 364,082 261,465 174,029 eliminate in consolidation all administrative fees from Superior. In addition, in December 2001, we acquired the Balance, remaining 10% equity interest in Superior in exchange for December 31 $ 91,181 $ 59,565 $ 45,805 7,143 shares of our common stock. Acquisitions in 2002 include reserves acquired in connec- Critical Accounting Policies tion with our acquisition of 80% of the outstanding capital Our significant accounting policies are more fully described stock of UHP. Acquisitions in 2001 include reserves acquired in Note 3 to our consolidated financial statements. Two of in connection with our acquisition of the remaining shares our accounting policies are particularly important to the of Superior HealthPlan. portrayal of our financial position and results of operations and require the application of significant judgment by our Changes in estimates of incurred claims for prior years management; as a result they are subject to an inherent recognized during 2002, 2001 and 2000 were attributable degree of uncertainty. to favorable development in all of our markets, including lower than anticipated utilization of medical services.
>>> 19 Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Intangible Assets million in 2001. This increase was due to organic growth in We have made several acquisitions over the past two years our existing markets, the purchase of the Texas SCHIP con- that collectively have resulted in our recording of a significant tracts and the inclusion of one month of revenues of UHP. amount of intangible assets. These intangible assets represent In addition, we received premium rate increases ranging the excess of cost over the fair market value of net assets from 1.5% to 10.7%, or 5.1% on composite basis across acquired in purchase transactions and consist of purchased our markets. contract rights, provider contracts and goodwill. Purchased contract rights are amortized using the straight-line method Administrative services fees for the year ended December 31, over periods ranging from 60 to 120 months. Provider 2002 increased $72,000, or 18.7%, to $457,000 from contracts are amortized using the straight-line method over $385,000 in 2001. This increase resulted from increases in 120 months. our non-risk SSI membership in our Texas market.
Our management evaluates whether events or circumstances Operating Expenses have occurred that may affect the estimated useful life or the Medical services costs for the year ended December 31, recoverability of the remaining balance of goodwill and 2002 increased $109.3 million, or 40.5%, to $379.5 million other identifiable intangible assets. Impairment of an intan- from $270.2 million in 2001. This increase reflected the gible asset is triggered when the estimated future undis- growth in our membership. counted cash flows (excluding interest charges) do not exceed the carrying amount of the intangible asset and related good- General and administrative expenses for the year ended will. If the events or circumstances indicate that the remain- December 31, 2002 increased $12.5 million, or 32.9%, to ing balance of the intangible asset and goodwill may be $50.4 million from $37.9 million in 2001. This increase permanently impaired, the potential impairment will be reflected a higher level of wages and related expenses for measured based upon the difference between the carrying additional staff to support our membership growth. amount of the intangible asset and goodwill and the fair value of such asset determined using the estimated future Other Income discounted cash flows (excluding interest charges) gener- Other income for the year ended December 31, 2002 ated from the use and ultimate disposition of the respective increased $6.0 million, or 168.1%, to $9.5 million from acquired entity. Our management must make assumptions $3.6 million in 2001. A majority of the increase is due to and estimates, such as the discount factor, in determining the the receipt of a one-time dividend of $5.1 million from a estimated fair values. While we believe these assumptions captive insurance company in which we maintained an and estimates are appropriate, other assumptions and investment. In addition, investment income increased due estimates could be applied and might produce significantly to a larger amount of dollars invested, and interest expense different results. decreased year over year due to the repayment of our subor- dinated debt in December 2001. Effective January 1, 2002, we ceased to amortize goodwill in accordance with SFAS No. 142, “Goodwill and Other Income Tax Expense Intangible Assets.” Goodwill is reviewed at least annually For the year ended December 31, 2002, we recorded income for impairment. In addition, we will perform an impairment tax expense of $15.6 million, or an effective tax rate of analysis of intangible assets more frequently based on other 38.0%. This compares to $9.1 million, or an effective tax factors. These factors would include significant changes in rate of 41.5%, for the year ended December 31, 2001. Our membership, state funding, medical contracts and provider effective tax rate decreased year over year due to our invest- networks and contracts. We did not recognize any impair- ment in tax-advantaged securities and our implementation ment losses during 2000, 2001 or 2002. of state tax saving strategies during 2002.
Results of Operations Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 Year Ended December 31, 2002 Compared to Revenues Year Ended December 31, 2001 Premiums for the year ended December 31, 2001 increased Revenues $109.8 million, or 50.7%, to $326.2 million from $216.4 Premiums for the year ended December 31, 2002 increased million in 2000. This increase was due to the Humana con- $134.8 million, or 41.3%, to $461.0 million from $326.2 tract purchases, the consolidation of our El Paso market and Centene Corporation and Subsidiaries
membership growth, net of the termination of our Indiana We received net proceeds of $41.0 million. Prior to this offer- subcontract arrangement. ing, we financed our operations and growth through private equity and debt financings and internally generated funds, Administrative services fees for the year ended December 31, raising $22.4 million between 1993 and 1998. This con- 2001 decreased $4.6 million, or 92.2%, to $385,000 from sisted of $18.4 million through the issuance of equity securi- $4.9 million in 2000 as a result of our acquisition of a ties and $4.0 million through subordinated debt financing. majority share of Superior HealthPlan, as described above. Our operating activities provided cash of $13.5 million in Operating Expenses 2000, $30.2 million in 2001 and $39.7 million in 2002. Medical services costs for the year ended December 31, The increases in 2001 and 2002 were due to further improved 2001 increased $87.7 million, or 48.0%, to $270.2 million profitability, an increase in membership and the timing of from $182.5 million in 2000. This increase was due to the capitation payments. Humana contract purchases, the consolidation of our El Paso market and membership growth, net of the termination of Our investing activities used cash of $14.6 million in 2000, our Indiana subcontract arrangement. provided cash of $2.7 million in 2001 and used cash of $79.7 million in 2002. Our investment policies are designed General and administrative expenses for the year ended to provide liquidity, preserve capital and maximize total December 31, 2001 increased $5.6 million, or 17.4%, to return on invested assets within our investment guidelines. $37.9 million from $32.3 million in 2000. This increase pri- Net cash provided by and used in investing activities will marily was due to a higher level of wages and related expenses fluctuate from year to year due to the timing of investment for additional staff to support our membership growth. purchases, sales and maturities. As of December 31, 2002, our investment portfolio consisted primarily of fixed- Other Income income securities with an average duration of 3.3 years. Other income for the year ended December 31, 2001 Cash is invested in investment vehicles such as municipal increased $2.9 million, or 434.4%, to $3.6 million from bonds, commercial paper, U.S. government-backed agencies $665,000 in 2000. This primarily reflected a significant and U.S. Treasury instruments. The states in which we increase in investment income due to an increase in cash, operate prescribe the types of instruments in which our cash equivalents and investments. The increase also reflected subsidiaries may invest their cash. The average portfolio the consolidation of our El Paso market due to our increased yield was 5.6% as of December 31, 2001 and 6.9% as of ownership. December 31, 2002, exclusive of a one-time dividend of $5.1 million from a captive insurance company in which we Income Tax Expense maintained an investment. For the year ended December 31, 2001, we recorded income tax expense of $9.1 million based on a 41.5% effective tax Our financing activities used cash of $2.4 million in 2000 rate. For the year ended December 31, 2000, we recorded and provided cash of $37.0 million in 2001 and $10.8 mil- an income tax benefit of $543,000 primarily as a result of lion in 2002. During 2000, financing cash flows consisted the reversal of our valuation allowance related to deferred of borrowings and repayments under a credit facility and tax assets. issuances of preferred stock. During 2001, financing cash flows primarily consisted of the issuance of common stock Liquidity and Capital Resources through our initial public offering net of the repayment of On May 22, 2002, we closed a follow-on public offering of subordinated notes with $4.0 million of our proceeds. 5,000,000 shares of common stock at $24.75 per share. Of During 2002, financing cash flows primarily consisted of the 5,000,000 shares, 4,600,000 shares were offered by sell- the issuance of common stock through our follow-on offer- ing stockholders and 400,000 by us. On June 5, 2002, the ing, the exercise of the over-allotment and proceeds received underwriters of our follow-on public offering exercised their from the exercise of stock options. over-allotment option to purchase 679,505 additional shares from selling stockholders and 70,495 shares from us. We may use our existing funds, including proceeds from our We received net proceeds of $10.3 million from the two two public offerings, to make strategic acquisitions includ- closings of the follow-on offering. ing Medicaid and SCHIP businesses, contract rights and related assets to increase our membership and to expand On December 18, 2001, we closed our initial public offering our business into new service areas. In 2002, we purchased of 3,250,000 shares of common stock at $14.00 per share. the capital stock of Bankers Reserve Life Insurance Company
>>> 21 Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
of Wisconsin for $479,000, net of assets and liabilities At December 31, 2002, we had working capital of $(8.8) acquired, and the rights to Texas Universities Health Plan’s million as compared to $35.7 million at December 31, 2001 SCHIP contracts for $595,000. In addition, we purchased and $(5.3) million at December 31, 2000. Our working cap- 80% of the outstanding capital stock of UHP for $10.6 mil- ital is negative at times due to our efforts to increase invest- lion. In 2001, we purchased the rights to the Humana ment returns through purchases of long-term investments, Medicaid contracts with the states of Texas and Wisconsin which have maturities of greater than one year and, there- for $1.2 million. In 2002, we spent $3.9 million on capital fore, are classified as long-term. Our investment policies are assets consisting primarily of new software, software and also designed to provide liquidity and preserve capital. We hardware upgrades, furniture, equipment and leasehold manage our short-term and long-term investments to ensure improvements related to office and market expansions. In that a sufficient portion is held in investments that are highly 2001, we purchased $3.6 million of furniture, equipment liquid and can be sold to fund working capital as needed. and leasehold improvements due to the addition of the Austin and San Antonio markets and the expansion of the Cash, cash equivalents and short-term investments were Wisconsin market. We anticipate spending $7.3 million on $69.2 million at December 31, 2002 and $90.0 million at additional capital expenditures in 2003 related to office and December 31, 2001. Long-term investments were $95.4 mil- market expansions and system upgrades. lion at December 31, 2002 and $22.3 million at December 31, 2001, including restricted deposits of $15.8 million and Our principal contractual obligations at December 31, 2002 $1.2 million, respectively. Cash and investments held by consisted of obligations under operating leases. The signifi- our unregulated entities totaled $52.0 million at December cant annual noncancelable lease payments over the next five 31, 2002. Based on our operating plan, we expect that our years and beyond are as follows (in thousands): cash, cash equivalents and investments, cash from our oper- ations and cash available under our credit facility will be Payment sufficient to finance our operations and capital expenditures Due for at least 12 months from the date of this report. 2003 $ 3,241 2004 3,124 Regulatory Capital and Dividend Restrictions 2005 3,026 Our operations are conducted through our subsidiaries, 2006 2,661 most of which are subject to state regulations that, among 2007 2,396 other things, require the maintenance of minimum levels of Thereafter 7,624 statutory capital, as defined by each state and restrict the $22,072 timing, payment and amount of dividends and other distri- butions that may be paid to us. In addition, we will acquire the remaining equity of UHP by no later than December 1, 2005, as described under Our subsidiaries are required to maintain minimum capital “Management’s Discussion and Analysis of Financial Con- requirements prescribed by various regulatory authorities in ditions and Results of Operations—Overview.” each of the states in which we operate. As of December 31, 2002, our subsidiaries had aggregate statutory capital and In May 2002, we entered into a $25 million revolving line surplus of $36.9 million, compared with the required mini- of credit facility with LaSalle Bank N.A. The line of credit mum aggregate statutory capital and surplus of $22.0 million. has a term of one year and has interest rates based on prime, floating and LIBOR rates. We granted a security interest in The National Association of Insurance Commissioners the common stock of our subsidiaries. The facility includes adopted guidelines which set minimum risk-based capital financial covenants, including requirements of minimum requirements for insurance companies, managed care organi- EBITDA and minimum tangible net worth. We are required zations and other entities bearing risk for healthcare coverage. to obtain LaSalle’s consent of any proposed acquisition that Wisconsin and Texas adopted various forms of the rules as of would result in a violation of any of the covenants con- December 31, 1999. As of December 31, 2002 our Wisconsin tained in the line of credit. As of December 31, 2002, we and Texas health plans were in compliance with risk-based were in compliance with all covenants and no funds had capital requirements. The managed care organization rules, been drawn on the facility. if adopted by Indiana and New Jersey, may increase the Centene Corporation and Subsidiaries
minimum capital required for these subsidiaries. We con- 1980. The transitions are complete and SFAS No. 44 is no tinue to monitor these requirements and do not expect that longer necessary. SFAS No. 145 amends SFAS No. 13, they will have a material impact on earnings or cash flows. “Accounting for Leases,” requiring that any capital lease that is modified resulting in an operating lease should be Recent Accounting Pronouncements accounted for under the sale-leaseback provisions of SFAS In July 2001, SFAS No. 142, “Goodwill and Other Intangible No. 98 or SFAS No. 28, as applicable. SFAS No. 145 is effec- Assets,” was issued which requires that goodwill and intan- tive for fiscal years beginning after May 15, 2002. The adop- gible assets with indefinite useful lives no longer be amor- tion of the provisions of SFAS No. 145 is not expected to tized, but instead tested at least annually for impairment. have a material impact on our results of operations, financial We have adopted SFAS No. 142 effective January 1, 2002, position or cash flows. and goodwill amortization was discontinued. For the year ended December 31, 2001, this adjustment would have In June 2002, SFAS No. 146, “Accounting for Costs Associated added $471,000 in net earnings, or $0.06 per diluted share with Exit or Disposal Activities,” was issued. It requires that and $0.34 per basic share. For the year ended December 31, a liability for a cost associated with an exit or disposal activ- 2000, this adjustment would have added $224,000 in net ity be recognized when the liability is incurred. This state- earnings, or $0.03 per diluted share and $0.25 per basic ment nullifies Emerging Issues Task Force Issue No. 94-3, share. Goodwill is reviewed at least annually for impair- “Liability Recognition for Certain Employee Termination ment. In addition, we will perform an impairment analysis Benefits and Other Costs to Exit an Activity (including of intangible assets more frequently based on other factors. Certain Costs Incurred in a Restructuring),” which required Such factors would include, but would not be limited to, that a liability for an exit cost be recognized upon the significant changes in membership, state funding, Medicaid entity’s commitment to an exit plan. SFAS No. 146 is effec- contracts and provider networks and contracts. We did not tive for exit or disposal activities that are initiated after recognize any impairment losses for the periods presented. December 31, 2002. The adoption of the provisions of SFAS No. 146 is not expected to have a material impact on our In August 2001, SFAS No. 144, “Accounting for the Impair- results of operations, financial position or cash flows. ment or Disposal of Long-Lived Assets,” was issued. SFAS No. 144 provides updated guidance concerning the recogni- In December 2002, SFAS No. 148, “Accounting for Stock- tion and measurement of an impairment loss for certain Based Compensation—Transition and Disclosure,” was types of long-lived assets. It also expands the scope of a dis- issued. This Statement amends FASB Statement No. 123, continued operation to include a component of an entity. “Accounting for Stock-Based Compensation,” to provide SFAS No. 144 is effective for financial statements issued for alternative methods of transition for an entity that voluntar- fiscal years beginning after December 15, 2001, and interim ily changes to the fair value based method of accounting for periods within those years. The adoption of the provisions stock-based employee compensation. In addition, this of SFAS No. 144 did not have a material impact on our Statement amends the disclosure requirements of SFAS results of operations, financial position or cash flows. No. 123 and APB Opinion No. 28, “Interim Financial Reporting,” to require prominent disclosures in both annual In May 2002, SFAS No. 145, “Rescission of FASB Statements and interim financial statements about the method of No. 4, 44, and 64, Amendment of FASB Statement No. 13, accounting for stock-based employee compensation and the and Technical Corrections as of April 2002,” was issued. effect of the method used on reported results. SFAS No. 148 As a result of the rescission of SFAS No. 4, gains and is effective for fiscal years ending after December 15, 2002 losses related to the extinguishment of debt should be clas- and for interim periods beginning after December 15, 2002. sified as extraordinary only if they meet the criteria outlined The adoption of the provisions of SFAS No. 148 did not under APB Opinion No. 30, “Reporting the Results of have a material impact on our results of operations, finan- Operations—Reporting the Effects of Disposal of a Segment cial position or cash flows. of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 64, In November 2002, FIN No. 45, “Guarantor’s Accounting “Extinguishments of Debt Made to Satisfy Sinking-Fund and Disclosure Requirements for Guarantees, Including Requirements,” was an amendment to SFAS No. 4 and is no Indirect Guarantees of Indebtedness of Others an Interpre- longer necessary. SFAS No. 44, “Accounting for Intangible tation of SFAS No. 5, 57, and 107 and Rescission of FASB Assets of Motor Carriers,” defined accounting requirements Interpretation No. 34,” was issued. FIN 45 clarifies the for the effects of the transition to the Motor Carrier Act of
>>> 23 Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
requirements of SFAS No. 5, “Accounting for Contingencies,” competition, expected activities and future acquisitions relating to a guarantor’s accounting for, and disclosure of, and investments, and the adequacy of our available cash the issuance of certain types of guarantees. resources. These statements may be found in the section of this report entitled “Management’s Discussion and Analysis We have adopted the disclosure requirements of FIN 45 as of Financial Condition and Results of Operations.” Readers required for fiscal years ending after December 15, 2002 are cautioned that matters subject to forward-looking state- and will adopt the provisions for initial recognition and ments involve known and unknown risks and uncertainties, measurement for all guarantees issued or modified after including economic, regulatory, competitive and other fac- December 31, 2002. The adoption of FIN 45 related to ini- tors that may cause our or our industry’s actual results, levels tial recognition and measurement of guarantees is not of activity, performance or achievements to be materially expected to have a significant impact on our net income or different from any future results, levels of activity, performance equity. We have completed an inventory of potential contin- or achievements expressed or implied by these forward- gencies and noted one potential guarantee that would looking statements. These statements are not guarantees of require the following disclosure in our financial statement future performance and are subject to risks, uncertainties footnotes per FIN 45: and assumptions.
“Within the Company’s Medicaid contract with the state of Actual results may differ from projections or estimates due Wisconsin, the Company is required to pay a fee if its contracted to a variety of important factors. Our results of operations physicians do not provide an adequate number of healthy exami- and projections of future earnings depend in large part on nations to certain member groups. This agreement constitutes a accurately predicting and effectively managing health bene- performance guarantee. At the end of each fiscal year, the fits and other operating expenses. A variety of factors, Company performs an analysis to estimate the amount owed to including competition, changes in healthcare practices, the state of Wisconsin, if any, under the performance guarantees. changes in federal or state laws and regulations or their The state of Wisconsin, however, does not calculate or request interpretations, inflation, provider contract changes, new payment for the amount owed until at least thirteen months sub- technologies, government-imposed surcharges, taxes or sequent to each year end. As such, the Company has recorded a assessments, reduction in provider payments by governmen- current payable for any portions owed within one year and a long- tal payers, major epidemics, disasters and numerous other term liability for portions owed for a period greater than one year factors affecting the delivery and cost of healthcare, such as from the balance sheet date. As of December 31, 2002 and 2001, major healthcare providers’ inability to maintain their oper- the Company recorded $2.0 million and $829,000, respectively, ations, may in the future affect our ability to control our of accounts payable and other accrued expenses for the current medical costs and other operating expenses. Governmental portions of the fees owed and $1.0 million at both year ends of action or business conditions could result in premium rev- other long-term liabilities for the long-term portions.” enues not increasing to offset any increase in medical costs and other operating expenses. Once set, premiums are On January 17, 2003, FIN 46, “Consolidation of Variable generally fixed for one-year periods and, accordingly, unan- Interest Entities, an Interpretation of ARB 51,” was issued. ticipated costs during such periods cannot be recovered The primary objectives of FIN 46 are to provide guidance on through higher premiums. The expiration, cancellation or the identification and consolidation of variable interest suspension of our Medicaid managed care contracts by the entities, or VIE, which are entities for which control is state governments would also negatively impact us. Due to achieved through means other than through voting rights. these factors and risks, we cannot give assurances with Our management has completed an analysis of FIN 46 and respect to our future premium levels or our ability to con- has determined that we do not have any VIEs. trol our future medical costs.
Forward-Looking Statements Factors That May Affect Future Results This report contains forward-looking statements that relate to future events or our future financial performance. We Risks Related to Being a Regulated Entity have attempted to identify these statements by terminology Reductions in Medicaid Funding Could Substantially including “believe,” “anticipate,” “plan,” “expect,” “esti- Reduce Our Profitability. mate,” “intend,” “seek,” “goal,” “may,” “will,” “should,” Nearly all of our revenues come from Medicaid premiums. “can,” “continue” or the negative of these terms or other The base premium rate paid by each state differs, depending comparable terminology. These statements include state- on a combination of factors such as defined upper payment ments about our market opportunity, our growth strategy, Centene Corporation and Subsidiaries
limits, a member’s health status, age, gender, county or • force us to restructure our relationships with providers region, benefit mix and member eligibility categories. Future within our network; levels of Medicaid premium rates may be affected by contin- require us to implement additional or different programs ued government efforts to contain medical costs and may • and systems; further be affected by state and federal budgetary constraints. Changes to Medicaid programs could reduce the number of • mandate minimum medical expense levels as a percent- persons enrolled or eligible, reduce the amount of reim- age of premiums revenues; bursement or payment levels, or increase our administrative restrict revenue and enrollment growth; or healthcare costs under those programs. States periodically • consider reducing or reallocating the amount of money they • require us to develop plans to guard against the financial spend for Medicaid. We believe that additional reductions insolvency of our providers; in Medicaid payments could substantially reduce our prof- increase our healthcare and administrative costs; itability. Further, our contracts with the states are subject to • cancellation by the state immediately or after a short notice • impose additional capital and reserve requirements; and period in the event of unavailability of state funds. • increase or change our liability to members in the event of malpractice by our providers. If Our Medicaid and SCHIP Contracts Are Terminated or Are Not Renewed, Our Business Will Suffer. For example, Congress has considered various forms of We provide managed care programs and select services to patient protection legislation commonly known as Patients’ individuals receiving benefits under Medicaid, including SSI Bills of Rights. We cannot predict the impact of this legisla- and SCHIP. We provide these healthcare services under con- tion, if adopted, on our business. tracts with regulatory entities in the areas in which we oper- ate. The contracts expire on various dates between June 30, Regulations May Decrease the Profitability of 2003 and December 31, 2003. Our contracts with the states Our Health Plans. of Indiana and Wisconsin accounted for 73% of our rev- Our Texas plans are required to pay a rebate to the state in enues for the year ended December 31, 2002. Our contracts the event profits exceed established levels. To date no may be terminated if we fail to perform up to the standards rebates have been required. This regulatory requirement, set by state regulatory agencies. In addition, the Indiana changes in this requirement or the adoption of similar contract under which we operate can be terminated by the requirements by our other regulators may limit our ability state without cause. Our contracts are generally intended to to increase our overall profits as a percentage of revenues. run for two years and may be extended for one or two addi- The State of Texas has implemented and is enforcing a tional years if the state or its contractor elects to do so. penalty provision for failure to pay claims in a timely man- When our contracts expire, they may be opened for bidding ner. Failure to meet this requirement can result in financial by competing healthcare providers. There is no guarantee fines and penalties. In addition, states may attempt to that our contracts will be renewed or extended. If any of our reduce their contract premium rates if regulators perceive contracts are terminated, not renewed, or renewed on less our medical loss ratio as too low. Any of these regulatory favorable terms, our business will suffer, and our operating actions could harm our operating results. results may be materially affected.
Also, on January 18, 2002, the federal government’s Centers Changes in Government Regulations Designed to Protect for Medicare and Medicaid Services, or CMS, published a Providers and Members Rather Than Our Stockholders final rule that removed an exception contained in the fed- Could Force Us to Change How We Operate and Could eral Medicaid reimbursement regulations permitting states Harm Our Business. to reimburse non-state government-owned or operated hos- Our business is extensively regulated by the states in which pitals for inpatient and outpatient hospital services at we operate and by the federal government. The applicable amounts up to 150 percent of a reasonable estimate of the laws and regulations are subject to frequent change and gen- amount that would be paid for the services furnished by erally are intended to benefit and protect health plan these hospitals under Medicaid payment principles. This providers and members rather than stockholders. Changes development in federal law could decrease the profitability in existing laws and rules, the enactment of new laws and of our health plans. rules, and changing interpretations of these laws and rules could, among other things:
>>> 25 Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Failure to Comply with Government Regulations Could In December 2000, HHS issued a new regulation mandating Subject Us to Civil and Criminal Penalties. heightened privacy and confidentiality protections under Federal and state governments have enacted fraud and abuse HIPAA that became effective on April 14, 2001. Compliance laws and other laws to protect patients’ privacy and access to with this regulation will be required by April 14, 2003. healthcare. Violation of these and other laws or regulations governing our operations or the operations of our providers The Bush Administration’s issuance of new regulations and could result in the imposition of civil or criminal penalties, its review of existing regulations, the states’ ability to prom- the cancellation of our contracts to provide services, the sus- ulgate stricter rules, and uncertainty regarding many aspects pension or revocation of our licenses or our exclusion from of the regulations may make compliance with the relatively participating in the Medicaid, SSI and SCHIP programs. new regulatory landscape difficult. Our existing programs Because of these potential sanctions, we seek to monitor our and systems may not enable us to comply in all respects compliance and that of our providers with federal and state with these new regulations. In order to comply with the reg- fraud and abuse and other healthcare laws on an ongoing ulatory requirements, we will be required to employ addi- basis. These penalties or exclusions, were they to occur as tional or different programs and systems, the costs of which the result of our actions or omissions, or our inability to are not expected to exceed $500,000 in 2003. Further, com- monitor the compliance of our providers, would negatively pliance with these regulations would require changes to impact our ability to operate our business. For example, fail- many of the procedures we currently use to conduct our ure to pay our providers promptly could result in the impo- business, which may lead to additional costs that we have sition of fines and other penalties. In some states, we may not yet identified. We do not know whether, or the extent to be subject to regulation by more than one governmental which, we will be able to recover our costs of complying authority, which may impose overlapping or inconsistent with these new regulations from the states. The new regula- regulations. tions and the related compliance costs could have a material adverse effect on our business. The Health Insurance Portability and Accountability Act of 1996, or HIPAA, broadened the scope of fraud and abuse Changes in Healthcare Law May Reduce Our Profitability. laws applicable to healthcare companies. HIPAA created Numerous proposals relating to changes in healthcare law civil penalties for, among other things, billing for medically have been introduced, some of which have been passed by unnecessary goods or services. HIPAA established new Congress and the states in which we operate or may operate enforcement mechanisms to combat fraud and abuse, in the future. Changes in applicable laws and regulations are including a whistle blower program. Further, HIPAA imposes continually being considered, and interpretations of existing civil and, in some instances, criminal penalties for failure to laws and rules may also change from time to time. We are comply with specific standards relating to the privacy, secu- unable to predict what regulatory changes may occur or rity and electronic transmission of individually-identifiable what effect any particular change may have on our business. health information. Congress may enact additional legisla- These changes could reduce the number of persons enrolled tion to increase penalties and to create a private right of or eligible for Medicaid and reduce the reimbursement or action under HIPAA, which would entitle patients to seek payment levels for medical services. More generally, we are monetary damages for violations of the privacy rules. unable to predict whether new laws or proposals will favor or hinder the growth of managed healthcare. Compliance with New Government Regulations May Require Us to Make Significant Expenditures. We cannot predict the outcome of these legislative or regula- In August 2000, the Department of Health and Human tory proposals or the effect that they will have on us. Services, or HHS, issued a new regulation under HIPAA Legislation or regulations that require us to change our requiring the use of uniform electronic data transmission current manner of operation, provide additional benefits or standards for healthcare claims and payment transactions change our contract arrangements may seriously harm our submitted or received electronically. We are required to operations and financial results. comply with the new regulation by October 2003, and Texas has indicated that it may impose an earlier compliance dead- Changes in Federal Funding Mechanisms May Reduce line. In August 1998, HHS proposed a regulation that would Our Profitability. require healthcare participants to implement organizational In February 2003, the Bush Administration proposed a and technical practices to protect the security of electroni- major long-term change in the way Medicaid and SCHIP are cally maintained or transmitted health-related information. funded. The proposal, if adopted, would allow states to elect to receive combined Medicaid-SCHIP “allotments” for acute Centene Corporation and Subsidiaries
and long-term healthcare for low-income, uninsured per- expenses related to medical services rise, our earnings would sons. Participating states would be given flexibility in be affected negatively. In addition, our actual medical serv- designing their own health insurance programs, subject to ices costs may exceed our estimates, which would cause our federally-mandated minimum coverage requirements. It is health benefits ratio, or our expenses related to medical uncertain whether this proposal will be enacted, or if so, services as a percentage of premium revenues, to increase how it may change from the initial proposal. Accordingly, it and our profits to decline. In addition, it is possible for a is unknown whether or how many states might elect to state to increase the rates payable to the hospitals without participate or how their participation may affect the net granting a corresponding increase in premiums to us. If this amount of funding available for Medicaid and SCHIP were to occur in one or more of the states in which we oper- programs. If such a proposal is adopted and decreases the ate, our profitability would be harmed. number of persons enrolled in Medicaid or SCHIP in the states in which we operate or reduces the volume of health- Failure to Effectively Manage Our Medical Costs or Related care services provided, our growth, operations and financial Administrative Costs Would Reduce Our Profitability. performance could be adversely affected. Our profitability depends, to a significant degree, on our ability to predict and effectively manage expenses related to If We Are Unable to Participate in SCHIP Programs, Our health benefits. We have less control over the costs related to Growth Rate May Be Limited. medical services than we do over our general and adminis- SCHIP is a relatively new federal initiative designed to pro- trative expenses. Historically, our health benefits ratio has vide coverage for low-income children not otherwise cov- varied. For example, our health benefits ratio was 82.3% for ered by Medicaid or other insurance programs. The programs 2002, 82.8% for 2001 and 84.3% for 2000, but was 88.9% vary significantly from state to state. Participation in SCHIP for 1999 and 88.4% for 1998. Because of the narrow mar- programs is an important part of our growth strategy. If gins of our health plan business, relatively small changes in states do not allow us to participate or if we fail to win bids our health benefits ratio can create significant changes in to participate, our growth strategy may be materially and our financial results. Changes in healthcare regulations and adversely affected. practices, the level of use of healthcare services, hospital costs, pharmaceutical costs, major epidemics, new medical If State Regulators Do Not Approve Payments of Dividends technologies and other external factors, including general and Distributions by Our Subsidiaries to Us, We May Not economic conditions such as inflation levels, are beyond Have Sufficient Funds to Implement Our Business Strategy. our control and could reduce our ability to predict and We principally operate through our health plan subsidiaries. effectively control the costs of providing health benefits. We If funds normally available to us become limited in the may not be able to manage costs effectively in the future. If future, we may need to rely on dividends and distributions our costs related to health benefits increase, our profits could from our subsidiaries to fund our operations. These sub- be reduced or we may not remain profitable. sidiaries are subject to regulations that limit the amount of dividends and distributions that can be paid to us without Failure to Accurately Predict Our Medical Expenses Could prior approval of, or notification to, state regulators. If these Negatively Affect Our Reported Results. regulators were to deny our subsidiaries’ request to pay divi- Our medical expenses include estimates of IBNR. We esti- dends to us, the funds available to our company as a whole mate our IBNR medical expenses monthly based on a num- would be limited. This could harm our ability to implement ber of factors. Adjustments, if necessary, are made to medical our business strategy. expenses in the period during which the actual claim costs are ultimately determined or when criteria used to estimate Risks Related to Our Business IBNR change. We cannot be sure that our IBNR estimates are adequate or that adjustments to those estimates will not Receipt of Inadequate Premiums Would Negatively Affect harm our results of operations. From time to time in the Our Revenues and Profitability. past, our actual results have varied from our estimates, par- Nearly all of our revenues are generated by premiums con- ticularly in times of significant changes in the number of our sisting of fixed monthly payments per member. These pre- members. Our failure to accurately estimate IBNR may also miums are fixed by contract, and we are obligated during affect our ability to take timely corrective actions, further the contract periods to provide healthcare services as estab- harming our results. lished by the state governments. We use a large portion of our revenues to pay the costs of healthcare services delivered to our customers. If premiums do not increase when
>>> 27 Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Difficulties in Executing Our Acquisition Strategy Could Accordingly, we may be unable to successfully identify, con- Adversely Affect Our Business. summate and integrate future acquisitions or operate Historically, the acquisition of Medicaid businesses, contract acquired businesses profitably. We also may be unable to rights and related assets of other health plans both in our obtain sufficient additional capital resources for future existing service areas and in new markets, has accounted for acquisitions. If we are unable to effectively execute our a significant amount of our growth. For example, our acqui- acquisition strategy, our future growth will suffer and our sition of 80% of the equity of UHP on December 1, 2002, results of operations could be harmed. accounted for 30.3% of the increase in our membership for the year ended December 31, 2002 compared to 2001. Failure to Achieve Timely Profitability in Any Business Many of the other potential purchasers of Medicaid assets Would Negatively Affect Our Results of Operations. have greater financial resources than we have. In addition, Start-up costs associated with a new business can be sub- many of the sellers are interested either in (1) selling, along stantial. For example, in order to obtain a certificate of with their Medicaid assets, other assets in which we do not authority in most jurisdictions, we must first establish a have an interest or (2) selling their companies, including provider network, have systems in place and demonstrate their liabilities, as opposed to the assets of their ongoing our ability to obtain a state contract and process claims. If businesses. we were unsuccessful in obtaining the necessary license, winning the bid to provide service or attracting members in We generally are required to obtain regulatory approval numbers sufficient to cover our costs, any new business of from one or more state agencies when making acquisitions. ours would fail. We also could be obligated by the state to In the case of an acquisition of a business located in a state continue to provide services for some period of time with- in which we do not currently operate, we would be required out sufficient revenue to cover our ongoing costs or recover to obtain the necessary licenses to operate in that state. In start-up costs. In addition, we may not be able to effectively addition, even if we may already operate in a state in which commercialize any new programs or services we seek to we acquire a new business, we would be required to obtain market to third parties. The expenses associated with start- additional regulatory approval if the acquisition would ing up a new business could have a significant impact on result in our operating in an area of the state in which we our results of operations if we are unable to achieve prof- did not operate previously. We cannot assure you that we itable operations in a timely fashion. would be able to comply with these regulatory requirements for an acquisition in a timely manner, or at all. In deciding We Derive All of Our Revenues from Operations in Four whether to approve a proposed acquisition, state regulators States, and Our Operating Results Would Be Materially may consider a number of factors outside our control, Affected by a Decrease in Revenues or Profitability in Any including giving preference to competing offers made by One of Those States. locally owned entities or by not-for-profit entities. Further- Operations in Wisconsin, Indiana, Texas and New Jersey more, our credit facility may prohibit some acquisitions account for all of our revenues. If we were unable to continue without the consent of our bank lender. to operate in each of those states or if our current operations in any portion of one of those states were significantly cur- In addition to the difficulties we may face in identifying and tailed, our revenues would decrease materially. In the first consummating acquisitions, we will also be required to inte- half of 2001, our membership in Indiana declined by approx- grate and consolidate any acquired business or assets with imately 46,000 due to a subcontracting provider organiza- our existing operations. This may include the integration of: tion terminating a percent-of-premium arrangement. In 2000, we reduced our service area in Wisconsin from 36 to • additional personnel who are not familiar with our oper- 18 counties. Our reliance on operations in a limited number ations and corporate culture; of states could cause our revenue and profitability to change suddenly and unexpectedly, depending on legislative actions, • existing provider networks, which may operate on differ- economic conditions and similar factors in those states. Our ent terms than our existing networks; inability to continue to operate in any of the states in which • existing members, who may decide to switch to another we operate would harm our business. healthcare plan; and Competition May Limit Our Ability to Increase Penetration • disparate administrative, accounting and finance, and of the Markets That We Serve. information systems. We compete for members principally on the basis of size and quality of provider network, benefits provided and quality Centene Corporation and Subsidiaries
of service. We compete with numerous types of competitors, claims brought against us are successful or have merit, they including other health plans and traditional state Medicaid will still be time-consuming and costly and could distract programs that reimburse providers as care is provided. Sub- our management’s attention. As a result, we may incur ject to limited exceptions by federally approved state appli- significant expenses and may be unable to operate our busi- cations, the federal government requires that there be choices ness effectively. for Medicaid recipients among managed care programs. Voluntary programs and mandated competition may limit We will be required to establish acceptable provider net- our ability to increase our market share. works prior to entering new markets. We may be unable to enter into agreements with providers in new markets on a Some of the health plans with which we compete have timely basis or under favorable terms. If we are unable greater financial and other resources and offer a broader to retain our current provider contracts or enter into new scope of products than we do. In addition, significant merger provider contracts timely or on favorable terms, our prof- and acquisition activity has occurred in the managed care itability will be harmed. industry, as well as in industries that act as suppliers to us, such as the hospital, physician, pharmaceutical, medical We May Be Unable to Attract and Retain Key Personnel. device and health information systems industries. To the We are highly dependent on our ability to attract and retain extent that competition intensifies in any market that qualified personnel to operate and expand our Medicaid we serve, our ability to retain or increase members and managed care business. If we lose one or more members of providers, or maintain or increase our revenue growth, pric- our senior management team, including our chief executive ing flexibility and control over medical cost trends may be officer, Michael F. Neidorff, who has been instrumental in adversely affected. developing our mission and forging our business relation- ships, our business and operating results could be harmed. In addition, in order to increase our membership in the We do not have an employment agreement with Mr. markets we currently serve, we believe that we must con- Neidorff, and we cannot assure you that we will be able to tinue to develop and implement community-specific prod- retain his services. Our ability to replace any departed mem- ucts, alliances with key providers and localized outreach bers of our senior management or other key employees may and educational programs. If we are unable to develop and be difficult and may take an extended period of time implement these initiatives, or if our competitors are more because of the limited number of individuals in the Medicaid successful than we are in doing so, we may not be able to managed care industry with the breadth of skills and experi- further penetrate our existing markets. ence required to operate and expand successfully a business such as ours. Competition to hire from this limited pool If We Are Unable to Maintain Satisfactory Relationships is intense, and we may be unable to hire, train, retain or With Our Provider Networks, Our Profitability Will motivate these personnel. Be Harmed. Our profitability depends, in large part, upon our ability to Negative Publicity Regarding the Managed Care Industry contract favorably with hospitals, physicians and other May Harm Our Business and Operating Results. healthcare providers. Our provider arrangements with our Recently, the managed care industry has received negative primary care physicians, specialists and hospitals generally publicity. This publicity has led to increased legislation, reg- may be cancelled by either party without cause upon 90 to ulation, review of industry practices and private litigation in 120 days’ prior written notice. We cannot guarantee that we the commercial sector. These factors may adversely affect will be able to continue to renew our existing contracts or our ability to market our services, require us to change our enter into new contracts enabling us to service our members services, and increase the regulatory burdens under which profitably. we operate. Any of these factors may increase the costs of doing business and adversely affect our operating results. From time to time providers assert or threaten to assert claims seeking to terminate noncancelable agreements due Claims Relating to Malpractice Could Cause Us to Incur to alleged actions or inactions by us. Even if these allega- Significant Expenses. tions represent attempts to avoid or renegotiate contractual Our providers and employees involved in medical care deci- terms that have become economically disadvantageous to sions may be subject to medical malpractice claims. Some the providers, it is possible that in the future a provider may states, including Texas, have adopted legislation that permits pursue such a claim successfully. Regardless of whether any managed care organizations to be held liable for negligent
>>> 29 Centene Corporation and Subsidiaries
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
treatment decisions or benefits coverage determinations. In We Intend to Expand Primarily into Markets Where addition, plaintiffs in cases pending in federal courts are Medicaid Recipients Are Required to Enroll in Managed seeking to hold managed care organizations liable for deny- Care Plans. ing medically necessary treatment and denying or delaying We expect to continue to focus our business in states in payments for services performed. Claims of this nature, if which Medicaid enrollment in managed care is mandatory. successful, could result in substantial damage awards against Currently, approximately two-thirds of the states require us and our providers that could exceed the limits of any health plan enrollment for Medicaid eligible participants in applicable insurance coverage. Therefore, successful mal- all or a portion of their counties. The programs are volun- practice or tort claims asserted against us, our providers or tary in other states. Because we concentrate on markets with our employees could adversely affect our financial condition mandatory enrollment, we expect the geographic expansion and profitability. Even if any claims brought against us are of our business to be limited to those states. unsuccessful or without merit, they would still be time- consuming and costly and could distract our management’s If We Are Unable to Integrate and Manage Our Information attention. As a result, we may incur significant expenses and Systems Effectively, Our Operations Could Be Disrupted. may be unable to operate our business effectively. Our operations depend significantly on effective information systems. The information gathered and processed by our Growth in the Number of Medicaid-Eligible Persons During information systems assists us in, among other things, mon- Economic Downturns Could Cause Our Operating Results itoring utilization and other cost factors, processing provider and Stock Prices to Suffer if State and Federal Budgets claims, and providing data to our regulators. Our providers Decrease or Do Not Increase. also depend upon our information systems for membership Less favorable economic conditions may cause our member- verifications, claims status and other information. ship to increase as more people become eligible to receive Medicaid benefits. During such economic downturns, how- Our information systems and applications require continual ever, state and federal budgets could decrease, causing states maintenance, upgrading and enhancement to meet our oper- to attempt to cut healthcare programs, benefits and rates. In ational needs. Moreover, our acquisition activity requires particular, we cannot predict the impact of acts of terrorism frequent transitions to or from, and the integration of, vari- or related military action on federal or state funding of ous information systems. We regularly upgrade and expand healthcare programs or on the size of the Medicaid-eligible our information systems capabilities. If we experience diffi- population. If federal funding were decreased or unchanged culties with the transition to or from information systems or while our membership was increasing, our results of opera- are unable to properly maintain or expand our information tions would suffer. systems, we could suffer, among other things, from opera- tional disruptions, loss of existing members and difficulty in Growth in the Number of Medicaid-Eligible Persons May attracting new members, regulatory problems and increases Be Countercyclical, Which Could Cause Our Operating in administrative expenses. In addition, our ability to inte- Results to Suffer When General Economic Conditions Are grate and manage our information systems may be impaired Improving. as the result of events outside our control, including acts of Historically, the number of persons eligible to receive nature, such as earthquakes or fires, or acts of terrorists. Medicaid benefits has increased more rapidly during periods of rising unemployment, corresponding to less favorable We May Not Be Able to Obtain or Maintain Adequate general economic conditions. Conversely, this number may Insurance. grow more slowly or even decline if economic conditions We maintain liability insurance, subject to limits and improve. Therefore, improvements in general economic con- deductibles, for claims that could result from providing or ditions may cause our membership levels to decrease, failing to provide managed care and related services. These thereby causing our operating results to suffer, which could claims could be substantial. We believe that our present lead to decreases in our stock price during periods in which insurance coverage and reserves are adequate to cover cur- stock prices in general are increasing. rently estimated exposures. We cannot assure you that we will be able to obtain adequate insurance coverage in the future at acceptable costs or that we will not incur signifi- cant liabilities in excess of policy limits. Centene Corporation and Subsidiaries
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Investments exceeds the general inflation rate. We use various strategies As of December 31, 2002, we had short-term investments of to mitigate the negative effects of healthcare cost inflation. $9.6 million and long-term investments of $95.4 million, Specifically, our health plans try to control medical and hos- including restricted deposits of $15.8 million. The short- pital costs through contracts with independent providers of term investments consist of highly liquid securities with healthcare services. Through these contracted care providers, maturities between three and 12 months. The long-term our health plans emphasize preventive healthcare and investments consist of municipal bonds, U.S. government- appropriate use of specialty and hospital services. backed agencies and U.S. Treasury investments, and have original maturities greater than one year. Restricted deposits While we currently believe our strategies to mitigate health- consist of investments required by various state statutes to care cost inflation will continue to be successful, competitive be deposited or pledged to state agencies. These investments pressures, new healthcare and pharmaceutical product are classified as long-term regardless of the contractual introductions, demands from healthcare providers and cus- maturity date due to the nature of the state’s requirements. tomers, applicable regulations or other factors may affect our These investments are subject to interest rate risk and will ability to control the impact of healthcare cost increases. decrease in value if market rates increase. We have the ability to hold these short-term investments to maturity, and as a Compliance Costs result, we would not expect the value of these investments Federal and state regulations governing standards for elec- to decline significantly as a result of a sudden change in tronic transactions, data security and confidentiality of market interest rates. Assuming a hypothetical and immedi- patient information have been issued recently. Due to the ate 1% increase in market interest rates at December 31, uncertainty surrounding the regulatory requirements, we 2002, the fair value of our fixed income investments would cannot be sure that the systems and programs that we have decrease by approximately $2.6 million. Similarly, a 1% implemented will comply adequately with the regulations decrease in market interest rates at December 31, 2002 that are ultimately adopted. Implementation of additional would result in an increase of the fair value of our invest- systems and programs will be required, the cost of which we ments of approximately $2.6 million. Declines in interest estimate not to exceed $500,000 in 2003. Further, compli- rates over time will reduce our investment income. ance with these regulations would require changes to many of the procedures we currently use to conduct our business, Inflation which may lead to additional costs that we have not yet Although the general rate of inflation has remained rela- identified. We do not know whether, or the extent to which, tively stable and healthcare cost inflation has stabilized in we will be able to recover our costs of complying with these recent years, the national healthcare cost inflation rate still new regulations from the states.
>>> 31 Centene Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31, 2002 2001
(In thousands, except share data) Assets: Current assets: Cash and cash equivalents $ 59,656 $ 88,867 Premium and related receivables, net of allowances of $219 and $3,879, respectively 16,773 7,032 Short-term investments, at fair value (amortized cost $9,687 and $1,166, respectively) 9,571 1,169 Deferred income taxes 2,846 2,515 Other current assets 4,243 2,464 Total current assets 93,089 102,047 Long-term investments, at fair value (amortized cost $78,025 and $20,923, respectively) 79,666 21,119 Restricted deposits, at fair value (amortized cost $15,561 and $1,204, respectively) 15,762 1,220 Property and equipment, net 6,295 3,796 Other assets 4,348 — Intangible assets, net 10,695 2,396 Deferred income taxes 472 788 Total assets $210,327 $131,366 Liabilities and stockholders’ equity: Current liabilities: Medical claims liabilities $ 91,181 $ 59,565 Accounts payable and accrued expenses 10,748 6,712 Total current liabilities 101,929 66,277 Other liabilities 5,334 1,000 Total liabilities 107,263 67,277 Minority interest 881 — Stockholders’ equity: Common stock, $.001 par value; authorized 40,000,000 shares; 10,829,099 and 10,085,112 shares issued and outstanding 11 10 Additional paid-in capital 72,377 60,857 Accumulated other comprehensive income: Net unrealized gain on investments, net of tax 1,087 135 Retained earnings 28,708 3,087 Total stockholders’ equity 102,183 64,089 Total liabilities and stockholders’ equity $210,327 $131,366
The accompanying notes are an integral part of these balance sheets. Centene Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
Year Ended December 31, 2002 2001 2000
(In thousands, except share data) Revenues: Premiums $461,030 $326,184 $216,414 Administrative services fees 457 385 4,936 Total revenues 461,487 326,569 221,350 Expenses: Medical services costs 379,468 270,151 182,495 General and administrative expenses 50,413 37,946 32,335 Total operating expenses 429,881 308,097 214,830 Earnings from operations 31,606 18,472 6,520 Other income (expense): Investment and other income, net 9,575 3,916 1,784 Interest expense (45) (362) (611) Equity in losses from joint ventures — — (508) Earnings from operations before income taxes 41,136 22,026 7,185 Income tax expense (benefit) 15,631 9,131 (543) Minority interest 116 —— Net earnings 25,621 12,895 7,728 Accretion of redeemable preferred stock — (467) (492) Net earnings attributable to common stockholders $ 25,621 $ 12,428 $ 7,236 Earnings per common share, basic: Net earnings per common share $2.45 $ 8.97 $ 8.03 Earnings per common share, diluted: Net earnings per common share $ 2.20 $ 1.61 $ 1.13 Shares used in computing per share amounts: Basic 10,477,360 1,385,399 901,526 Diluted 11,644,077 8,019,497 6,819,595
The accompanying notes are an integral part of these statements.
>>> 33 Centene Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY For the Years Ended December 31, 2002, 2001 and 2000 (In thousands, except share data)
Preferred Stock
Series A Series B Series C Shares Amt Shares Amt Shares Amt Balance, December 31, 1999 733,850 $ 123 864,640 $ 144 557,850 $ 93 Net earnings — — — — — — Net unrealized investment gains, net of $136 tax — — — — — — Comprehensive earnings Series D preferred stock accretion — — — — — — Balance, December 31, 2000 733,850 $ 123 864,640 $ 144 557,850 $ 93 Net earnings — — — — — — Net unrealized investment gains, net of $32 tax — — — — — — Comprehensive earnings Issuance of common stock upon exercise of options — — — — — — Purchase of stock — — — — — — Stock compensation expense — — — — — — Series D preferred stock accretion — — — — — — Exercise of warrants to purchase common stock — — — — — — Conversion of Series A, B, C and D preferred stock to common stock (733,850) (123) (864,640) (144) (557,850) (93) Conversion of Series A and B common stock to $.001 par value common stock — — — — — — Issuance of 3,250,000 shares of common stock, net — — — — — — Issuance of common stock for purchase of joint venture interest — — — — — — Balance, December 31, 2001 — $ — — $ — — $ — Net earnings — — — — — — Net unrealized investment gains, net of $559 tax — — — — — — Comprehensive earnings Issuance of common stock in relation to stock options and employee stock purchase plan — — — — — — Issuance of 470,495 shares of common stock, net — — — — — — Stock compensation expense — — — — — — Tax benefit of disqualifying dispositions — — — — — — Balance, December 31, 2002 —$— —$— —$ —
The accompanying notes are an integral part of these statements. Centene Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY For the Years Ended December 31, 2002, 2001 and 2000 / In thousands, except share data (continued)
Common Stock Common Stock Net $.001 Par Additional Unrealized Retained Series A Series B Value Paid-in Gain (Loss) on Earnings Shares Amt Shares Amt Shares Amt Capital Investments (Deficit) Total 277,247 $ 1 624,279 $ 2 — $ — $ 7 $ (216) $(16,521) $(16,367) — — — — — — — — 7,728 7,728 — — — — — — — 297 297 8,025 — — — — — — — — (492) (492) 277,247 $ 1 624,279 $ 2 — $ — $ 7 $ 81 $ (9,285) $ (8,834) — — — — — — — — 12,895 12,895 —— —— —— — 54 — 54 12,949 19,100 — — — — — 32 — — 32 (11,000) — — — — — (30) — (56) (86) —— —— —— 6 — — 6 — — — — — — — — (467) (467) — — 46,003 — — — 18 — — 18
— — — — 5,872,340 6 19,683 — — 19,329
(285,347) (1) (670,282) (2) 955,629 1 2 — — — — — — — 3,250,000 3 41,039 — — 41,042
— — — — 7,143 — 100 — — 100 — $— — $ — 10,085,112 $10 $60,857 $ 135 $ 3,087 $ 64,089 — — — — — — — — 25,621 25,621 — — — — — — — 952 — 952 26,573
— — — — 273,492 — 491 — — 491 — — — — 470,495 1 10,317 — — 10,318 —— —— —— 270 — — 270 — — — — — — 442 — — 442 — $ — — $ — 10,829,099 $11 $72,377 $1,087 $ 28,708 $102,183
>>> 35 Centene Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 2002 2001 2000
(In thousands) Cash flows from operating activities: Net earnings $ 25,621 $ 12,895 $ 7,728 Adjustments to reconcile net earnings to net cash provided by operating activities— Depreciation and amortization 2,565 1,847 1,034 Stock compensation expense 270 6— Minority interest (116) —— (Gain) loss on sale of investments (649) (390) 40 Equity in losses from joint ventures — —508 Changes in assets and liabilities— (Increase) decrease in premium and related receivables (2,449) 9,406 (4,087) (Increase) decrease in other current assets (1,463) (238) 684 Increase in deferred income taxes (574) (37) (584) Decrease in other assets 857 —— Increase in medical claims liabilities 15,386 8,686 8,466 Decrease in unearned premiums (827) — (3,601) Increase (decrease) in accounts payable and accrued expenses 1,910 (1,987) 3,270 Decrease in other liabilities (872) —— Net cash provided by operating activities 39,659 30,188 13,458 Cash flows from investing activities: Purchase of property and equipment (3,918) (3,635) (642) Purchase of investments (192,371) (25,481) (20,260) Sales and maturities of investments 127,706 25,037 7,382 Contract acquisitions (595) (1,250) — Investments in subsidiaries (10,501) 7,995 (1,097) Net cash (used in) provided by investing activities (79,679) 2,666 (14,617) Cash flows from financing activities: Payment of note payable — — (2,350) Payment of subordinated debt — (4,000) — Proceeds from exercise of stock options 491 32 — Net proceeds from issuance of common stock 10,318 41,042 — Purchase of stock — (102) — Proceeds from exercise of warrants — 18 — Net cash provided by (used in) financing activities 10,809 36,990 (2,350) Net (decrease) increase in cash and cash equivalents (29,211) 69,844 (3,509) Cash and cash equivalents, beginning of period 88,867 19,023 22,532 Cash and cash equivalents, end of period $ 59,656 $ 88,867 $ 19,023 Interest paid $28$920$531 Income taxes paid $ 16,433 $ 9,460 $ 310
The accompanying notes are an integral part of these statements. Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dollars in thousands, except share data
1. Organization and Operations 3. Summary of Significant Accounting Policies Centene Corporation (Centene or the Company) provides The accompanying consolidated financial statements include managed care programs and related services to individuals the accounts of Centene Corporation and all majority owned receiving benefits under Medicaid, including Supplemental subsidiaries. All material intercompany balances and trans- Security Income (SSI), and State Children’s Health Insurance actions have been eliminated. Program (SCHIP). Centene operates under its own state licenses in Wisconsin, Indiana, Texas and New Jersey, and Cash and Cash Equivalents contracts with other managed care organizations to provide Investments with original maturities of three months or less risk and nonrisk management services. at the date of acquisition are considered to be cash equiva- lents. Cash equivalents consist of commercial paper, money Centene’s managed care organization (MCO) subsidiaries market funds and bank savings accounts. include Managed Health Services Insurance Corp. (MHSIC), a wholly owned Wisconsin corporation; Coordinated Care Investments Corporation Indiana, Inc. (CCCI), a wholly owned Indiana Short-term investments include securities with original corporation; Superior HealthPlan, Inc. (Superior), a wholly maturities between three months and one year. Long-term owned Texas corporation (39% before January 1, 2001); investments include securities with original maturities and University Health Plans, Inc. (UHP), an 80% owned greater than one year. New Jersey corporation. Short-term and long-term investments are classified as avail- Centene’s other subsidiaries include Bankers Reserve Life able for sale and are carried at fair value based on quoted Insurance Company of Wisconsin (Bankers Reserve), a market prices. Unrealized gains and losses on investments wholly owned Wisconsin corporation that the Company available for sale are excluded from earnings and reported as purchased on March 14, 2002, and NurseWise, Inc., a wholly a separate component of stockholders’ equity, net of income owned Delaware corporation that was incorporated in tax effects. Premiums and discounts are amortized or accreted August of 2002. over the life of the related security using the effective interest method. The Company monitors the difference between the The Company is currently operated as one business segment, cost and fair value of investments. Investments that experi- which includes both its underwritten and administrative ence a decline in value that is judged to be other than tem- only services provided to individuals receiving benefits porary are written down to fair value and a realized loss is under Medicaid, including SSI, and SCHIP. recorded in investment and other income. To calculate real- ized gains and losses on the sale of investments, the 2. Initial Public Offering and Follow-on Company uses the specific amortized cost of each invest- On December 13, 2001, the Company completed an initial ment sold. Realized gains and losses are recorded in public offering (IPO) of 3,250,000 shares of its common investment and other income. stock at $14.00 per share. The net proceeds, after paying the underwriting discount and expenses associated with the As part of the Company’s acquisition of UHP, certain call offering, were $41,000. In conjunction with the IPO all out- and put option rights were received and granted (see Note standing shares of preferred stock were converted into 21). The Company is in the process of obtaining third-party shares of common stock in accordance with their terms. valuations related to the fair value of the call and put options, which may result in an increase or decrease in the On May 22, 2002, the Company closed a follow-on public portion of the purchase price allocated to goodwill. The fair offering of 5,000,000 shares of common stock at $24.75 per value of the call option, once determined, will be evaluated share. Of the 5,000,000 shares, 4,600,000 shares were offered for impairment. To the extent that impairment would be by selling stockholders and 400,000 by the Company. On determined, adjustments would be recorded as a charge to June 5, 2002, the underwriters of the follow-on public offer- investment income. The fair value of the put option, once ing exercised their over-allotment option to purchase determined, will be evaluated on a quarterly basis, with 679,505 additional shares from selling stockholders and adjustments in the fair values being recorded as a charge or 70,495 additional shares from the Company. Centene credit to investment income. received net proceeds of $10,300 from the two closings of the follow-on offering.
>>> 37 Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Dollars in thousands, except share data
The Company did not own any unaffiliated equity invest- Intangible Assets ments as of December 31, 2002. During 2002 and 2001, the Intangible assets represent the excess of cost over the fair Company maintained an equity investment in an unaffili- market value of net assets acquired in purchase transactions ated reinsurance company. The estimated fair value of this and consist of purchased contract rights, provider contracts investment, which approximated the original cost, was not and goodwill. Purchased contract rights are amortized using significant and was included within other long-term invest- the straight-line method over periods ranging from 60 to ments as of December 31, 2001. This investment was sold 120 months. Provider contracts are amortized using the in July 2002. straight-line method over 120 months.
Restricted Deposits Effective January 1, 2002, the Company ceased to amortize Restricted deposits consist of investments required by various goodwill in accordance with SFAS No. 142, “Goodwill and state statutes to be deposited or pledged to state agencies. Other Intangible Assets.” Goodwill is reviewed at least These investments are classified as long-term, regardless of annually for impairment. In addition, the Company will the contractual maturity date due to the nature of the states’ perform an impairment analysis of intangible assets more requirements. frequently based on other factors. Such factors would include, but are not limited to, significant changes in Under the State of New Jersey Department of Banking and membership, state funding, medical contracts and provider Insurance (DOBI) regulations, UHP is required to maintain networks and contracts. An impairment loss is recognized if certain insolvency deposits in a custodial account for the the carrying value of goodwill exceeds the implied fair value. protection of enrollees. UHP is entitled to receive interest The Company did not recognize any impairment losses for income on these deposits; however, the principal may the periods presented. not be withdrawn without the written consent of the Commissioner of the DOBI. The minimum deposit require- Medical Claims Liabilities ment is calculated on December 31 of each year and must Medical services costs include claims paid, claims adjudi- be funded by June 30 of the following year. The restricted cated but not yet paid, estimates for claims received but not amounts are invested in money market funds. The mini- yet adjudicated, estimates for claims incurred but not yet mum deposit requirement based on the December 31, 2002 received and estimates for the costs necessary to process calculation is $15,422. The total unfunded balance at unpaid claims. December 31, 2002 is $3,237. The Company intends to fund the minimum deposit requirement from unrestricted The estimates of medical claims liabilities are developed cash and cash equivalents. using standard actuarial methods based upon historical data for payment patterns, cost trends, product mix, seasonality, All other restricted deposit requirements were fully funded utilization of healthcare services and other relevant factors on December 31, 2002. including product changes. These estimates are continually reviewed and adjustments, if necessary, are reflected in the Property and Equipment period known. Furniture, equipment and leasehold improvements are car- ried at cost less accumulated depreciation. Depreciation for Accounts Payable and Accrued Expenses furniture and equipment, other than computer equipment, Accounts payable and accrued expenses include accrued is calculated based on the estimated useful lives of the assets wages and related payroll taxes, federal and state tax payables ranging between five and seven years. Depreciation for com- and payments owed to vendors for services performed in the puter equipment is calculated using the straight-line method normal course of business. based on a three-year life. Software is stated at cost and is amortized over its estimated useful life of three years using Other Assets and Liabilities the straight-line method. Depreciation for leasehold Other assets and liabilities consist principally of Separate improvements is calculated using the straight-line method Account assets of $4,298 and related Separate Account based on the shorter of the estimated useful lives of the liabilities of $4,298 as of December 31, 2002 (see Note 24). asset or the term of the respective leases, ranging between In addition, other liabilities include certain payments due to three and ten years. various states related to minimum performance guarantees. Centene Corporation and Subsidiaries
Premium Revenue and Related Receivables Reinsurance recoveries were approximately $1,542, $3,958 The majority of the Company’s premium revenue is received and $1,454 in 2002, 2001 and 2000, respectively. Reinsur- monthly based on fixed rates per member as determined by ance expenses were approximately $3,981, $10,252 and the state contracts. Some contracts allow for additional pre- $3,391 in 2002, 2001 and 2000, respectively. Reinsurance mium related to certain supplemental services provided recoveries, net of expenses, are included in medical serv- such as maternity deliveries. The revenue is recognized as ices costs. earned over the covered period of services. Premiums col- lected in advance are recorded as unearned premiums. Other Income (Expense) Premiums due to the Company are recorded as premium Other income (expense) consists principally of investment and related receivables and are recorded net of an allowance and other income and interest expense. Investment income based on historical trends and management’s judgement on is derived from the Company’s cash, cash equivalents and the collectibility of these accounts. investments. For the year ended December 31, 2002, invest- ment income included a $5,100 one-time dividend from a As the Company generally receives premiums during the captive insurance company in which the Company main- month in which services are provided, the allowance is typi- tained an investment. For the year ended December 31, cally not significant in comparison to total premium revenue. 2000, other income included equity in losses from a joint From 1998 to 2000, however, Centene provided Medicaid venture. Interest expense for the year ended December 31, services in certain regions of Indiana as a subcontractor with 2002, included commitment fees paid to a bank in conjunc- Maxicare Indiana, Inc. In June 2001, the Insurance Com- tion with the Company’s revolving line of credit. Interest missioner of the Indiana Department of Insurance declared expense for the years ended December 31, 2001 and 2000, Maxicare insolvent and ordered Maxicare into liquidation. reflected interest paid on the Company’s subordinated As a result, Centene recorded an allowance for uncollectible notes, which were paid in full in December 2001. receivables in the amount of $2,700 to fully reserve for all receivables from Maxicare as of December 31, 2001. In Income Taxes 2002, subsequent to a release and settlement agreement Centene recognizes deferred tax assets and liabilities for the with Maxicare and the Indiana Insurance Commissioner future tax consequences attributable to differences between which requires no payment by either Maxicare or Centene, the financial statement carrying amounts of existing assets Centene wrote off the entire balance of the receivable from and liabilities and their respective tax bases. Deferred tax Maxicare as uncollectible and reduced the related allowance assets and liabilities are measured using enacted tax rates for doubtful accounts. There are no contractual allowances expected to apply to taxable income in the years in which related to Centene’s premium revenue. those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a Significant Customers change in tax rates is recognized in income in the period Centene receives the majority of its revenues under contracts that includes the enactment date of the tax rate change. or subcontracts with state Medicaid managed care programs. The contracts, which expire on various dates between Estimates June 30, 2003 and December 31, 2003, are expected to be The preparation of financial statements in conformity with renewed. Our contracts with the states of Wisconsin, generally accepted accounting principles requires manage- Indiana and Texas accounted for 44%, 30% and 24%, ment to make estimates and assumptions that affect the respectively, of the Company’s revenues for the year ended reported amounts of assets and liabilities and disclosure of December 31, 2002. contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and Reinsurance expenses during the reporting period. Actual results could Centene’s MCO subsidiaries have purchased reinsurance differ from those estimates. from third parties to cover eligible healthcare services. The current reinsurance agreements generally cover 90% of Reclassifications inpatient healthcare expenses in excess of annual deductibles Certain 2001 amounts in the consolidated financial state- of $75 to $150 per member, up to a lifetime maximum of ments have been reclassified to conform to the 2002 presen- $2,000. The subsidiaries are responsible for inpatient tation. These reclassifications have no effect on net earnings charges in excess of an average daily per diem. or shareholders’ equity as previously reported.
>>> 39 Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Dollars in thousands, except share data
Recent Accounting Pronouncements a result of the rescission of SFAS No. 4, gains and losses In July 2001, Statement of Financial Accounting Standards related to the extinguishment of debt should be classified as No. 142, “Goodwill and Other Intangible Assets,” was issued extraordinary only if they meet the criteria outlined under which requires that goodwill and intangible assets with APB Opinion No. 30, “Reporting the Results of Operations— indefinite useful lives no longer be amortized, but instead Reporting the Effects of Disposal of a Segment of a Business, tested at least annually for impairment. The Company has and Extraordinary, Unusual and Infrequently Occurring adopted SFAS No. 142 effective January 1, 2002 and good- Events and Transactions.” SFAS No. 64, “Extinguishments of will amortization was discontinued. Goodwill is reviewed at Debt Made to Satisfy Sinking-Fund Requirements,” was an least annually for impairment. In addition, the Company amendment to SFAS No. 4 and is no longer necessary. SFAS will perform an impairment analysis of intangible assets No. 44, “Accounting for Intangible Assets of Motor Carriers,” more frequently based on other factors. Such factors would defined accounting requirements for the effects of the tran- include, but are not limited to, significant changes in sition to the Motor Carrier Act of 1980. The transitions are membership, state funding, medical contracts and provider complete and SFAS No. 44 is no longer necessary. SFAS No. networks and contracts. The Company did not recognize 145 amends SFAS No. 13, “Accounting for Leases,” requir- any impairment losses for the periods presented. ing that any capital lease that is modified resulting in an operating lease should be accounted for under the sale- The effect of this adjustment on net earnings as well as basic leaseback provisions of SFAS No. 98 or SFAS No. 28, as and diluted earnings per share for the years ended December applicable. SFAS No. 145 is effective for fiscal years begin- 31, 2001 and 2000, follows: ning after May 15, 2002. The adoption of the provisions of SFAS No. 145 is not expected to have a material impact on 2001 2000 the Company’s results of operations, financial position or Net earnings, as reported $12,428 $7,236 cash flows. Goodwill amortization 471 224 Adjusted net earnings $12,899 $7,460 In June 2002, SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” was issued. It requires that Earnings Per Common Share, Basic: a liability for a cost associated with an exit or disposal activ- Net earnings, as reported $ 8.97 $ 8.03 ity be recognized when the liability is incurred. This state- Goodwill amortization 0.34 0.25 ment nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Adjusted net earnings $ 9.31 $ 8.28 Benefits and Other Costs to Exit an Activity (including Earnings Per Common Share, Diluted: Certain Costs Incurred in a Restructuring),” which required Net earnings, as reported $ 1.61 $ 1.13 that a liability for an exit cost be recognized upon the entity’s Goodwill amortization 0.06 0.03 commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December Adjusted net earnings $ 1.67 $ 1.16 31, 2002. The adoption of the provisions of SFAS No. 146 is not expected to have a material impact on the Company’s In August 2001, SFAS No. 144, “Accounting for the Impair- results of operations, financial position or cash flows. ment or Disposal of Long-Lived Assets,” was issued. SFAS No. 144 provides updated guidance concerning the recogni- In December 2002, SFAS No. 148, “Accounting for Stock- tion and measurement of an impairment loss for certain Based Compensation—Transition and Disclosure,” was types of long-lived assets. It also expands the scope of a dis- issued. This Statement amends FASB Statement No. 123, continued operation to include a component of an entity. “Accounting for Stock-Based Compensation,” to provide SFAS No. 144 is effective for financial statements issued for alternative methods of transition for an entity that voluntar- fiscal years beginning after December 15, 2001, and interim ily changes to the fair value based method of accounting for periods within those years. The adoption of the provisions stock-based employee compensation. In addition, this of SFAS No. 144 did not have a material impact on the Statement amends the disclosure requirements of SFAS No. Company’s results of operations, financial position or 123 and APB Opinion No. 28, “Interim Financial Reporting,” cash flows. to require prominent disclosures in both annual and In May 2002, SFAS No. 145, “Rescission of FASB Statements interim financial statements about the method of account- No. 4, 44, and 64, Amendment of FASB Statement No. 13, ing for stock-based employee compensation and the effect and Technical Corrections as of April 2002,” was issued. As of the method used on reported results. SFAS No. 148 is Centene Corporation and Subsidiaries
effective for fiscal years ending after December 15, 2002 and “Within the Company’s Medicaid contract with the state of for interim periods beginning after December 15, 2002. The Wisconsin, the Company is required to pay a fee if its contracted adoption of the provisions of SFAS No. 148 did not have a physicians do not provide an adequate number of healthy exami- material impact on the Company’s results of operations, nations to certain member groups. This agreement constitutes a financial position or cash flows. performance guarantee. At the end of each fiscal year, the Company performs an analysis to estimate the amount owed to In November 2002, FIN No. 45, “Guarantor’s Accounting the state of Wisconsin, if any, under the performance guarantees. and Disclosure Requirements for Guarantees, Including The state of Wisconsin, however, does not calculate or request Indirect Guarantees of Indebtedness of Others, an Interpre- payment for the amount owed until at least thirteen months sub- tation of SFAS No. 5, 57, and 107 and Rescission of FASB sequent to each year end. As such, the Company has recorded a Interpretation No. 34,” was issued. FIN 45 clarifies the current payable for any portions owed within one year and a long- requirements of SFAS No. 5, “Accounting for Contingencies,” term liability for portions owed for a period greater than one year relating to a guarantor’s accounting for, and disclosure of, from the balance sheet date. As of December 31, 2002 and 2001, the issuance of certain types of guarantees. the Company recorded $2,004 and $829, respectively, of accounts payable and other accrued expenses for the current por- Centene has adopted the disclosure requirements of FIN 45 tions of the fees owed and $1,036 and $1,000, respectively, of as required for fiscal years ending after December 15, 2002 other long-term liabilities for the long-term portions.” and will adopt the provisions for initial recognition and measurement for all guarantees issued or modified after On January 17, 2003, FIN 46, “Consolidation of Variable December 31, 2002. The adoption of FIN 45 related to ini- Interest Entities, an Interpretation of ARB 51,” was issued. tial recognition and measurement of guarantees is not The primary objectives of FIN 46 are to provide guidance on expected have a significant impact on the net income or the identification and consolidation of variable interest equity of the Company. The Company has completed an entities, or VIE’s, which are entities for which control is inventory of potential contingencies and noted one poten- achieved through means other than through voting rights. tial guarantee that would require the following disclosure The Company has completed an analysis of FIN 46 and has per FIN 45: determined that it does not have any VIEs.
4. Short-Term and Long-Term Investments and Restricted Deposits Short-term and long-term investments and restricted deposits available for sale by investment type consist of the following:
December 31, 2002 Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 2,797 $ 204 $ (3) $ 2,998 Commercial paper 13,278 — — 13,278 State/municipal securities and other 87,198 1,669 (144) 88,723 Total $103,273 $1,873 $(147) $104,999
December 31, 2001 Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 17,998 $ 216 $ (3) $ 18,211 Commercial paper 462 3 — 465 State/municipal securities and other 4,833 8 (9) 4,832 Total $ 23,293 $ 227 $ (12) $ 23,508
>>> 41 Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Dollars in thousands, except share data
The contractual maturity of short-term and long-term investments and restricted deposits as of December 31, 2002, are as follows: Investments Restricted Deposits Estimated Estimated Amortized Market Amortized Market Cost Value Cost Value One year or less $ 9,687 $ 9,571 $12,764 $12,764 One year through five years 34,065 34,637 1,882 1,985 Five years through ten years 35,544 36,611 915 1,013 After ten years 8,416 8,418 — — Total $87,712 $89,237 $15,561 $15,762
Actual maturities may differ from contractual maturities due to call or prepayment options.
The Company recorded realized gains and losses on the sale 6. Intangible Assets of investments for the years ended December 31 as follows: Intangible assets at December 31 consist of the following:
2002 2001 2000 2002 2001 Gross realized gains $698 $424 $ 57 Goodwill $ 6,255 $ 2,464 Gross realized losses (49) (34) (97) Purchased contract rights 3,885 1,410 Provider contracts 2,400 — Net realized gains/(losses) $649 $390 $(40) Total intangibles 12,540 3,874 Various state statutes require MCOs to deposit or pledge min- Less accumulated amortization: imum amounts of investments to state agencies. Securities Goodwill (1,233) (1,233) with an amortized cost of $15,561 and $1,204 were Purchased contract rights (592) (245) deposited or pledged to state agencies by Centene’s MCO Provider contracts (20) — subsidiaries at December 31, 2002 and 2001, respectively. Total accumulated amortization (1,845) (1,478) These investments are classified as long-term restricted Intangible assets, net $10,695 $ 2,396 deposits in the consolidated financial statements due to the nature of the states’ requirements. Amortization expense was $367, $648 and $224 for the years ended December 31, 2002, 2001 and 2000, respec- 5. Property and Equipment tively. The estimated amortization expense for each of the Property and equipment consist of the following as of next five years, assuming no further acquisitions, is December 31: approximately $800. 2002 2001 7. Income Taxes Furniture and office equipment $6,461 $ 4,349 Centene files a consolidated federal income tax return while Computer software 4,724 2,423 Centene and each subsidiary file separate state income tax Leasehold improvements 1,286 878 returns. Building 434 — Land 151 10 The consolidated income tax expense (benefit) consists of 13,056 7,660 the following for the years ended December 31: Less—accumulated depreciation (6,761) (3,864) 2002 2001 2000 Property and equipment, net $ 6,295 $ 3,796 Current: Federal $13,661 $7,952 $ 629 Depreciation expense for the years ended December 31, State 2,338 1,624 625 2002, 2001 and 2000 was $1,887, $1,199, and $810, respectively. Total current 15,999 9,576 1,254 Deferred (368) (445) (1,797) Total expense (benefit) $15,631 $9,131 $ (543) Centene Corporation and Subsidiaries
The following is a reconciliation of the expected income tax December 31, 2000. As a result, the income tax benefit expense (benefit) as calculated by multiplying pretax income recorded for 2000 includes the reversal of $3,764 of deferred by federal statutory rates and Centene’s actual income tax tax valuation allowance. benefit for the years ended December 31: 8. Medical Claims Liabilities 2002 2001 2000 The change in medical claims liabilities is summarized Expected federal income as follows: tax expense $14,398 $7,709 $ 2,443 2002 State income taxes, net Balance, January 1 $ 59,565 of federal income Acquisitions 16,230 tax benefit 1,520 1,141 412 Incurred related to: Tax exempt investment Current year 399,141 income (411) —— Prior years (19,673) Equity in losses of joint ventures, net of tax — — 175 Total incurred 379,468 Change in valuation Paid related to: allowance — — (3,764) Current year 326,636 Other, net 124 281 191 Prior years 37,446 Income tax expense Total paid 364,082 (benefit) $15,631 $9,131 $ (543) Balance, December 31 $ 91,181 Federal statutory rates for the years ended December 31, Acquisitions in 2002 include reserves acquired in connection 2002, 2001 and 2000 were 35%, 35% and 34%, respectively. with the Company’s acquisition of 80% of the outstanding capital stock of UHP. Temporary differences that give rise to deferred tax assets and liabilities are presented below for the years ended Changes in estimates of incurred claims for prior years rec- December 31: ognized during 2002 were attributable to favorable develop- 2002 2001 ment in all of our markets, including lower than anticipated Medical claims liabilities and utilization of medical services. other accruals $3,848 $2,279 Allowance for doubtful accounts 81 1,435 The Company had reinsurance recoverables related to paid Depreciation and amortization 702 353 and unpaid medical claims liabilities of $2,738 and $1,202 Other 8 18 at December 31, 2002 and 2001, respectively, included in premiums and other receivables. Total deferred tax assets 4,639 4,085 Other 1,321 782 9. Revolving Line of Credit Total deferred tax liabilities 1,321 782 In May 2002, the Company entered into a $25,000 revolving line of credit facility with LaSalle Bank N.A. The line of credit Net deferred tax assets and liabilities $3,318 $3,303 has a term of one year and has interest rates based on prime, floating and LIBOR rates. The Company granted a security The Company is required to record a valuation allowance interest in the common stock of its subsidiaries. The facility when it is more likely than not that some portion or all of includes financial covenants, including requirements of the deferred tax assets will not be realized. Management minimum EBITDA and minimum tangible net worth. The determined that a valuation allowance was no longer neces- Company is required to obtain LaSalle’s consent of any pro- sary for its federal net operating loss carryforward as of posed acquisition that would result in a violation of any of the covenants contained in the line of credit. As of December 31, 2002, no funds had been drawn on the facility.
>>> 43 Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Dollars in thousands, except share data
10. Notes Payable and Subordinated Debt 12. Stockholders’ Equity As of December 31, 2002 and 2001, the Company has no Upon completion of the Company’s IPO in December 2001, outstanding debt. each outstanding share of each class of common stock and preferred stock was converted into one share of a single class During 2001 and 2000, the Company had subordinate of $.001 par value common stock. Prior to the IPO, the promissory notes with principal balances due ranging from Company had three classes of preferred stock outstanding $0 to $4,000. Interest was due and payable annually in and included in equity. They were Series A, Series B and September at a rate of 8.5%. In the event that the Company Series C preferred stock. did not comply with the terms of the subordinated promis- sory notes, the Company would be considered to be in Holders of common stock are entitled to one vote for each default on its debt and the interest rate would be 10.5%. share of common stock held.
During 2000, the Company was in default on its promissory Effective November 2001, the Company changed its state of notes due to late interest payments. In December 2001, all incorporation from Wisconsin to Delaware. Under the of the promissory notes and related accrued interest were Delaware Certificate of Incorporation, the Company has paid in full. Interest expense for the years ended December 10,000,000 authorized shares of preferred stock at $.001 par 31, 2001 and 2000 was $362 and $611, respectively. value and 40,000,000 authorized shares of common stock at $.001 par value. At December 31, 2002, there were no 11. Redeemable Preferred Stock preferred shares outstanding. Upon completion of the Company’s IPO in December 2001, all outstanding shares of Series D redeemable preferred stock During 2001, Centene had warrants outstanding to pur- were converted into 3,716,000 shares of common stock. chase 60,000 shares of the Company’s Series D preferred stock at an exercise price of $5.00 per share. In addition, Series D preferred stock was convertible, at the option of the there were warrants outstanding to purchase 7,432 of the holder, into common stock at an initial conversion rate of Company’s common stock at an exercise price of $2.40 per one common share for each preferred share and was auto- share. Prior to the completion of the Company’s IPO, all matically converted at an initial public offering. Series D outstanding warrants were exercised. preferred stock was redeemable for cash at the option of the holder for up to 50% of that holder’s Series D preferred 13. Statutory Capital Requirements stock outstanding on each of September 1, 2003, and Various state laws require Centene’s subsidiaries to maintain September 1, 2004, at a price equal to the sum of (1) $5.50 minimum capital requirements. At December 31, 2002 and per share plus (2) an amount equal to any dividends 2001, Centene’s subsidiaries had aggregate statutory capital declared or accrued but unpaid on such shares. Series D and surplus of $36,900 and $16,300, respectively, compared preferred stock was entitled to an initial liquidation prefer- with the required minimum aggregate statutory capital and ence in the amount of $5.00 per share. surplus of $22,000 and $9,100, respectively.
Redeemable preferred stock is summarized as follows: 14. Dividend Restrictions Under the laws of the states of which the Company operates, Series D the Company’s regulated subsidiaries are required to obtain Shares Amount approval for dividends from the appropriate state regulatory Balance, December 31, 1999 3,718,000 $ 18,386 body. The Company received dividends of $4,000 from its Preferred stock accretion — 492 managed care subsidiaries during 2002. No dividends were Balance, December 31, 2000 3,718,000 18,878 declared in 2001 or 2000. Preferred stock accretion — 467 Purchase of stock (2,000) (16) 15. Stock Option Plans Conversion to common (3,716,000) (19,329) As of December 31, 2002, Centene had five stock option plans (the Plans) for issuance of common stock. The Plans Balance, December 31, 2001 — — allow for the granting of options to purchase common stock Purchase of stock — — at the market price at the date of grant for key employees, Conversion to common — — consultants, and other individual contributors of or to Balance, December 31, 2002 — $ — Centene. Both incentive options and nonqualified stock Centene Corporation and Subsidiaries
options can be awarded under the Plans. Each option ten years after date of grant. The Plans have reserved awarded under the Plans is exercisable as determined by the 2,200,000 shares for option grants. Options granted gener- Board of Directors upon grant. Further, depending on the ally vest over a five-year period. Vesting generally begins on type of grant, no option will be exercisable for longer than the anniversary of the date of grant and annually thereafter.
Option activity for the years ended December 31 is summarized below: 2002 2001 2000 Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price Options outstanding, beginning of year 1,422,940 $ 2.65 1,410,040 $ 1.68 955,992 $1.91 Granted 487,500 24.82 139,000 11.99 531,000 1.26 Exercised (277,400) 1.65 (19,100) 1.71 — — Canceled (79,400) 10.98 (107,000) 1.82 (76,952) 1.69 Options outstanding, end of year 1,553,640 $ 9.38 1,422,940 $ 2.67 1,410,040 $1.68 Weighted average remaining life 7.4 years 7.6 years 7.7 years Weighted average fair value of options granted $15.07 $5.59 $0.37
The following table summarizes information about options outstanding as of December 31, 2002:
Options Outstanding Options Vested Weighted Average Range of Options Remaining Weighted Average Options Weighted Average Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price $ 0.00–$ 3.43 988,040 6.2 $ 1.74 576,440 $ 1.99 $ 3.44–$ 6.87 13,800 8.2 5.25 1,000 5.25 $ 6.88–$10.30 25,000 8.7 7.78 6,250 7.78 $10.31–$13.73 — — — — — $13.74–$17.17 61,800 9.0 16.26 8,400 16.98 $17.18–$20.60 5,000 9.1 18.86 — — $20.61–$24.03 288,000 9.5 22.57 4,250 20.71 $24.04–$27.46 44,000 9.7 25.66 — — $27.47–$30.90 94,500 9.6 29.43 — — $30.91–$34.33 33,500 10.0 32.13 — — 1,553,640 7.4 $ 9.38 596,340 $ 2.40
The Company accounts for the Plans in accordance with the exercise price. Compensation expense is then recognized on intrinsic value based method of Accounting Principles a straight-line basis over the years the employees’ services Board Opinion No. 25 as permitted by SFAS No. 123. are received (over the vesting period), generally five years. Accordingly, compensation cost related to stock options No compensation cost related to the Plans was charged issued to employees is calculated on the date of grant only if against income during 2000. During 2002 and 2001, the the current market price of the underlying stock exceeds the Company recognized $270 and $6, respectively, in noncash
>>> 45 Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Dollars in thousands, except share data
compensation expense related to the issuance of stock options. Had compensation cost for the Plans been determined based on the fair value method at the grant dates as specified in SFAS No. 123, Centene’s net earnings would have been reduced to the following pro forma amounts:
2002 2001 2000 Net earnings, as reported $25,621 $12,895 $7,728 Accretion of redeemable preferred stock — (467) (492) Net earnings attributable to common stockholders 25,621 12,428 7,236 Total stock-based employee compensation expense determined under fair value based method, net of related tax effects 6,170 665 110 Pro forma net earnings $19,451 $11,763 $7,126 Earnings Per Common Share: Basic, as reported $2.45 $ 8.97 $ 8.03 Basic, pro forma 1.86 8.49 7.90 Diluted, as reported $ 2.20 $ 1.61 $ 1.13 Diluted, pro forma 1.67 1.53 1.12 Shares Used in Computing Per Share Amounts: Basic 10,447,360 1,385,399 901,526 Diluted 11,644,077 8,019,497 6,819,595
The fair value of each option grant is estimated on the date Retirement Plan covering all eligible employees. Expenses of the grant using an option pricing model with the follow- under the Retirement Plan were $312, $306 and $203 dur- ing assumptions: no dividend yield; expected volatility of 1% ing the years ended December 31, 2002, 2001 and 2000, through the date of the IPO; 50% through the end of 2001; respectively. and 54% for 2002, risk-free interest rate of 3.6%, 4.9% and 5.3% and expected lives of 7.4, 7.6 and 7.7 for the years During 2002, Centene implemented an executive retirement ended December 31, 2002, 2001 and 2000, respectively. savings plan (Executive Plan). This Plan is a voluntary, non- qualified deferred compensation plan designed to provide During 2002, Centene implemented an employee stock pur- executive employees with tax-deferred savings opportunities. chase plan. Under this plan, eligible employees are permit- Under the Executive Plan, eligible employees may contribute ted to purchase shares of the Company’s common stock at a a percentage of their base salary, subject to certain limitations. discounted price through payroll withholdings. At the end of each plan period, the Company issues stock to participating 17. Related-Party Transactions employees at a price equal to 85% of the lesser of the closing No related party transactions occurred in 2002. Certain stock price on either the first business day of the plan period members of Centene’s Board of Directors performed con- or the exercise date. The Company has reserved 300,000 sulting services for the Company totaling $3 in 2001 and shares of common stock and issued 1,792 shares in 2002. $36 in 2000. Legal fees of $94 and $48 were paid in 2001 and 2000, respectively, to a law firm affiliated through a 16. Retirement Plan stockholder of the Company. Centene has a defined contribution plan (Retirement Plan) which covers substantially all employees who work at least 18. Commitments 1,000 hours in a twelve consecutive month period and are Centene and its subsidiaries lease office facilities and vari- at least twenty-one years of age. Under the Retirement Plan, ous equipment under noncancelable operating leases. In eligible employees may contribute a percentage of their base addition to base rental costs, Centene and its subsidiaries salary, subject to certain limitations. Centene may elect to are responsible for property taxes and maintenance for both match a portion of the employee’s contribution. In addi- facility and equipment leases. Rental expense was $2,109, tion, Centene may make a profit sharing contribution to the $1,704 and $1,383 for the years ended December 31, 2002, Centene Corporation and Subsidiaries
2001 and 2000, respectively. The significant annual non- Costs in excess of those anticipated could have a material cancelable lease payments over the next five years and adverse effect on the Company’s results of operations. thereafter are as follows: Financial instruments that potentially subject the Company 2003 $ 3,241 to concentrations of credit and interest rate risks consist 2004 3,124 primarily of cash and cash equivalents, investments in mar- 2005 3,026 ketable securities and accounts receivable. The Company 2006 2,661 invests its excess cash in interest bearing deposits with 2007 2,396 major banks, commercial paper, government and agency Thereafter 7,624 securities, and money market funds. Investments in mar- $22,072 ketable securities are managed within guidelines established by the Company’s Board of Directors. The Company carries 19. Risks and Uncertainties these investments at fair value. The Company is a party to various legal actions normally associated with the managed care industry, the aggregate Concentrations of credit risk with respect to accounts receiv- effect of which is presently unknown. able are limited due to significant customers paying as services are rendered. Significant customers include the fed- The Company’s profitability depends in large part on accu- eral government and the states in which Centene operates. rately predicting and effectively managing medical services The Company has a risk of incurring loss if its allowance for costs. The Company continually reviews its premium and doubtful accounts is not adequate. benefit structure to reflect its underlying claims experience and revised actuarial data; however, several factors could As discussed in Note 3 to the consolidated financial state- adversely affect the medical services costs. Certain of these ments, the Company has reinsurance agreements with factors, which include changes in healthcare practices, infla- insurance companies. The Company monitors the insurance tion, new technologies, major epidemics, natural disasters companies’ financial ratings to determine compliance with and malpractice litigation, are beyond any health plan’s standards set by state law. The Company has a credit risk control and could adversely affect the Company’s ability to associated with these reinsurance agreements to the extent accurately predict and effectively control healthcare costs. the reinsurers are unable to pay valid reinsurance claims of the Company.
20. Earnings Per Share The following table sets forth the calculation of basic and diluted net earnings per share for the years ended December 31:
2002 2001 2000 Net earnings $25,621 $12,895 $7,728 Accretion of redeemable preferred stock — (467) (492) Net earnings attributable to common stockholders $25,621 $12,428 $7,236 Shares used in computing per share amounts: Weighted average number of common shares outstanding 10,477,360 1,385,399 901,526 Dilutive effect of stock options and warrants (as determined by applying the treasury stock method) and convertible preferred stock 1,166,717 6,634,098 5,918,069 Weighted average number of common shares and potential dilutive common shares outstanding 11,644,077 8,019,497 6,819,595 Earnings Per Common Share, Basic: Net earnings per common share $2.45 $ 8.97 $ 8.03 Earnings Per Common Share, Diluted: Net earnings per common share $ 2.20 $ 1.61 $ 1.13
>>> 47 Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Dollars in thousands, except share data
21. Joint Ventures—University Health Plans, Inc. Assets On December 1, 2002, Centene purchased 80% of the out- Cash and cash equivalents $ 3,324 standing capital stock of University Health Plans, Inc. UHP Premium and related receivables 6,604 is a managed health plan serving approximately 53,000 Other current assets 215 Medicaid members in 15 counties throughout New Jersey. Property and equipment, net 468 Centene paid approximately $10,630 in cash and expenses. Restricted deposits 12,173 In accordance with terms in the agreement, the purchase Intangible assets: price may be adjusted based on certain conditions up to one Goodwill 3,791 year after the acquisition date. The results of operations for Purchased contract rights 1,400 UHP are included in the consolidated financial statements Provider network 2,400 since December 1, 2002. Centene will operate UHP as a Total assets $30,375 joint venture with the third-party owner, and Centene will manage UHP’s operations in a manner consistent with its Liabilities and Stockholders’ Equity other Medicaid health plans. The joint venture investment is Accrued medical claims $16,230 consistent with Centene’s strategy to enter new markets Accounts payable and accrued liabilities 2,518 where it sees an opportunity for organic growth in Medicaid Minority interest 997 managed care. Stockholders’ equity 10,630 Total liabilities and stockholders’ equity $30,375 The stock purchase agreement provides terms for Centene’s future purchase of the remaining 20% of UHP’s outstanding The following unaudited pro forma information presents capital stock. This future purchase is in the form of a call the results of operations of Centene and subsidiaries as if the and put option. The call option allows Centene to purchase acquisition described above had occurred as of January 1, the additional 20% of outstanding shares for cash within 2001. Effective July 1, 2002, the state of New Jersey nine months after the original acquisition date at an aggre- excluded the General Assistance population from managed gate purchase price of $2,600. The put option requires the care programs. In addition, effective November 22, 2002, in third-party owner to transfer, convey, assign and deliver the contemplation of its Stock Purchase Agreement with Centene, additional 20% of outstanding common stock to Centene UHP entered into an agreement with a third party related to on the third anniversary following the original acquisition its commercial membership. Any members not enrolling date. The put option allows Centene to acquire the addi- with the third party will not be renewed by UHP. As a result, tional shares based on its “deemed value” at such point in pro forma adjustments include UHP earnings before taxes time. The “deemed value” is defined as an amount equal to excluding the financial results of the General Assistance the greater of (i) $2,600 or (ii) the enterprise value, as estab- population and the commercial membership. In addition, lished by mutual agreement of the parties, of UHP as of the pro forma adjustments include the amortization of the date of exchange multiplied by the percentage of the intangibles, excluding goodwill, before taxes of $348 in outstanding common stock. 2002 and $380 in 2001. The pro forma adjustments to earn- ings are net of taxes at Centene’s effective tax rates and have The condensed balance sheet below includes the purchase been adjusted for the 20% minority interest in UHP by a price allocation at the acquisition date. Goodwill is not third party. These pro forma results may not necessarily amortized and is not deductible for tax purposes. The state reflect the actual results of operations that would have been contract and provider network will be amortized over a ten- achieved, nor are they necessarily indicative of future results year period. The value of the common stock acquired is of operations. being determined based on the fair value of tangible assets 2002 2001 and liabilities acquired as well as external valuations of identifiable intangible assets. Revenue $567,048 $395,155 Net earnings before accretion of Centene is in the process of obtaining third-party valuations redeemable preferred stock 25,986 12,305 related to certain intangible assets, including the value asso- Net earnings 25,986 11,838 ciated with the options to purchase the remaining 20% of Basic earnings per share 2.48 8.54 UHP’s outstanding common stock; thus, the allocation of Diluted earnings per share 2.23 1.53 the purchase price is subject to refinement. Centene Corporation and Subsidiaries
22. Joint Ventures—Superior HealthPlan Inc. 23. Contract Acquisitions From 1998 through 2000, Centene owned 39% of Superior In June 2002, Superior HealthPlan entered into an agree- and, therefore, accounted for the investment under the ment with Texas Universities Health Plan Inc. to purchase equity method of accounting. Superior participates in the the SCHIP contracts in three Texas service areas. Effective state of Texas medical assistance program. Superior had no September 1, October 1 and November 1, 2002, the state of enrolled membership during 1998, but became fully opera- Texas approved the contract sales between Superior and Texas tional on December 1, 1999. Under the terms of a manage- Universities Health Plan. As a result of this transaction, ment agreement, a wholly owned subsidiary of Centene $595 was recorded as an intangible asset, purchased con- performs third-party administrative services for Superior. tract rights. Centene is amortizing the contract rights on a This agreement generated $4,936 of administrative service straight-line basis over five years, the period expected to be fees during 2000. benefited.
Summary financial information for Superior as of and for In December 2000, MHSIC and Superior entered into agree- the year ended December 31 follows: ments with Humana Inc. to transfer Humana’s Medicaid 2000 contract with the state of Wisconsin to MHSIC and Total assets $ 7,284 Humana’s Medicaid contract with the state of Texas to Stockholders’ deficit (1,481) Superior. Effective February 1, 2001, the state of Wisconsin Revenues 34,102 approved the agreement, thereby allowing MHSIC to serve Net loss (1,303) approximately 35,000 additional members in the state. Company’s equity in net loss (508) Effective February 1, 2001, the state of Texas approved a management agreement between Superior and Humana Effective January 1, 2001, Centene purchased an additional Inc., thereby allowing Superior to manage approximately 51% of Superior for $290 in cash, increasing Centene’s own- 30,000 additional members in Texas. As a result of these ership to 90%. Centene began consolidating Superior’s transactions, $1,250 was recorded as an intangible asset operations from that point forward. When the change in purchased contract rights. Centene is amortizing the con- ownership occurred, goodwill of $1,200 was recorded as tract rights on a straight-line basis over five years, the period part of the transaction. In December 2001, Centene pur- expected to be benefited. chased the remaining shares of Superior for $100 in stock, increasing Centene’s ownership to 100%. At December 31, 24. Bankers Reserve Acquisition 2001, all intercompany transactions between Centene and On March 14, 2002, the Company completed an acquisi- Superior have been eliminated in consolidation. tion of Bankers Reserve Life Insurance Company of Wisconsin (Bankers Reserve) for a cash purchase price of $3,527. The The following unaudited pro forma summary information Company allocated the purchase price to net tangible and presents the consolidated statement of earnings information identifiable intangible assets based on their fair value. as if the aforementioned transaction had been consum- Centene allocated $479 to identifiable intangible assets, mated on January 1, 2000, and does not purport to be representing the value assigned to acquired licenses, which indicative of what would have occurred had the acquisition are being amortized on a straight-line basis over a period of been made at that date or of the results which may occur in ten years. The Company accounted for this acquisition the future. under the purchase method of accounting and accordingly, Year Ended the consolidated results of operations include the results of December 31, 2000 the acquired Bankers Reserve business from the date of Total revenues $250,516 acquisition. The Company has excluded pro forma disclo- Net earnings attributable to sures related to the impact of Bankers Reserve on the results common stockholders 6,441 of operations for the twelve-month period ended December Diluted net earnings per 31, 2002, as well as the comparable period in the preceding common share .94
>>> 49 Centene Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Dollars in thousands, except share data
year. Such disclosures have been excluded as there are no annuity contracts. Accordingly, there is no income statement significant continuing operations as of the date of acquisi- impact to the Company as a result of acquiring the Separate tion, outside of the run-off of Separate Account activity. Account assets and liabilities. The Separate Account bal- ances, which are being liquidated and paid to insureds as As part of the acquisition, the Company acquired $5,200 of annuities mature, do not have a minimum guarantee bene- Separate Account assets and $5,200 of Separate Account lia- fit beyond the cash surrender value of the policy. bilities. The acquired Separate Account assets and liabilities represent fixed rate annuity contracts with various maturity Centene acquired Bankers Reserve for the purpose of dates. Concurrent with the acquisition of Bankers Reserve, providing reinsurance coverage to its existing managed care the Company entered into a 100% coinsurance reinsurance Medicaid entities. It is not currently anticipated that agreement with an unaffiliated party to reinsure the guaran- Bankers Reserve would be used to offer reinsurance to teed cash value, annuity benefit, surrender benefit and unaffiliated entities. death benefits associated with these contracts. The reinsur- ance premiums paid for this coverage equal the net admin- The intercompany reinsurance activity is eliminated on a istrative fee earned and received by the Company on the consolidated basis. Centene Corporation and Subsidiaries
CERTIFICATIONS
I, Michael F. Neidorff, certify that: —have presented in this annual report our conclusions about the effectiveness of the disclosure controls and 1. I have reviewed this annual report on Form 10-K of procedures based on the required evaluation as of Centene Corporation; that date;
2. based on my knowledge, this annual report does not con- 5. Mr. Witty and I have disclosed, based on our most recent tain any untrue statement of a material fact or omit to evaluation, to the auditors of Centene Corporation and state a material fact necessary to make the statements to the audit committee of the board of directors of made, in light of the circumstances under which such Centene Corporation: statements were made, not misleading with respect to the —all significant deficiencies in the design or operation of period covered by this annual report; internal controls that could adversely affect the ability of Centene Corporation to record, process, summarize and 3. based on my knowledge, the financial statements, and report financial data and have identified for such audi- other financial information included in this annual tors any material weaknesses in internal controls; and report, fairly present in all material respects the financial condition, results of operations and cash flows of —any fraud, whether or not material, that involves man- Centene Corporation as of, and for, the periods presented agement or other employees who have a significant role in this annual report; in the internal controls of Centene Corporation; and
4. Karey L. Witty, the Senior Vice President, Chief Financial 6. Mr. Witty and I have indicated in this annual report Officer and Treasurer of Centene Corporation, and I: whether or not there were significant changes in internal controls or in other factors that could significantly affect —are responsible for establishing and maintaining dis- internal controls subsequent to the date of our evalua- closure controls and procedures (as defined for pur- tion, including any corrective actions with regard to sig- poses of Rule 13a-14 under the Securities and Exchange nificant deficiencies and material weaknesses. Act of 1934, as amended) for Centene Corporation; —have designed such disclosure controls and procedures to ensure that material information relating to Centene /s/ MICHAEL F. NEIDORFF Corporation, including its consolidated subsidiaries, is Michael F. Neidorff made known to us by others within those entities, par- President and Chief Executive Officer ticularly during the period in which this annual report (principal executive officer) was prepared; —have evaluated the effectiveness of the disclosure con- Date: February 24, 2003 trols and procedures of Centene Corporation as of a date within 90 days prior to the filing date of this annual report; and
>>> 51 Centene Corporation and Subsidiaries
CERTIFICATIONS
I, Karey L. Witty, certify that: —have presented in this annual report our conclusions about the effectiveness of the disclosure controls and 1. I have reviewed this annual report on Form 10-K of procedures based on the required evaluation as of Centene Corporation; that date;
2. based on my knowledge, this annual report does not con- 5. Mr. Neidorff and I have disclosed, based on our most tain any untrue statement of a material fact or omit to recent evaluation, to the auditors of Centene Corporation state a material fact necessary to make the statements and to the audit committee of the board of directors of made, in light of the circumstances under which such Centene Corporation: statements were made, not misleading with respect to the —all significant deficiencies in the design or operation of period covered by this annual report; internal controls that could adversely affect the ability of Centene Corporation to record, process, summarize and 3. based on my knowledge, the financial statements, and report financial data and have identified for such audi- other financial information included in this annual tors any material weaknesses in internal controls; and report, fairly present in all material respects the financial condition, results of operations and cash flows of —any fraud, whether or not material, that involves man- Centene Corporation as of, and for, the periods presented agement or other employees who have a significant role in this annual report; in the internal controls of Centene Corporation; and
4. Mr. Michael F. Neidorff, the President and Chief Executive 6. Mr. Neidorff and I have indicated in this annual report Officer of Centene Corporation, and I: whether or not there were significant changes in internal controls or in other factors that could significantly affect —are responsible for establishing and maintaining dis- internal controls subsequent to the date of our evalua- closure controls and procedures (as defined for pur- tion, including any corrective actions with regard to sig- poses of Rule 13a-14 under the Securities and Exchange nificant deficiencies and material weaknesses. Act of 1934, as amended) for Centene Corporation; —have designed such disclosure controls and procedures to ensure that material information relating to Centene /s/ KAREY L. WITTY Corporation, including its consolidated subsidiaries, is Karey L. Witty made known to us by others within those entities, par- Senior Vice President, Chief Financial Officer ticularly during the period in which this annual report and Treasurer was prepared; (principal financial and —have evaluated the effectiveness of the disclosure con- accounting officer) trols and procedures of Centene Corporation as of a date within 90 days prior to the filing date of this Date: February 24, 2003 annual report; and REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Centene Corporation:
In our opinion, the accompanying consolidated balance believe that our audit provides a reasonable basis for our sheet as of December 31, 2002, and the related consolidated opinion. The financial statements of the Company as of statement of earnings, stockholders’ equity and cash flows December 31, 2001, and for each of the two years in the present fairly, in all material respects, the financial position period ended December 31, 2001, were audited by other of Centene Corporation and its subsidiaries (the “Company”) independent accountants who have ceased operations. at December 31, 2002, and the results of their operations Those independent accountants expressed an unqualified and their cash flows for the year then ended in conformity opinion on those financial statements in their report dated with accounting principles generally accepted in the United February 1, 2002. States of America. These financial statements are the respon- sibility of the Company’s management; our responsibility is As discussed in Note 3 to the consolidated financial state- to express an opinion on these financial statements based ments, in 2002 the Company changed its method of on our audit. We conducted our audit of these statements in accounting for goodwill to conform with Statement of accordance with auditing standards generally accepted in Financial Accounting Standards No. 142, “Goodwill and the United States of America, which require that we plan Other Intangible Assets.” and perform the audit to obtain reasonable assurance about whether the financial statements are free of material mis- statement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles PRICEWATERHOUSECOOPERS LLP used and significant estimates made by management, and St. Louis, Missouri evaluating the overall financial statement presentation. We February 14, 2003
>>> 53 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The following report is a copy of a report previously issued by Arthur Andersen LLP and has not been reissued by Arthur Andersen LLP.
To Centene Corporation:
We have audited the accompanying consolidated balance the overall financial statement presentation. We believe that sheets of Centene Corporation (a Delaware corporation) and our audits provide a reasonable basis for our opinion. subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of earnings, stockholders’ In our opinion, the consolidated financial statements equity and cash flows for each of the three years in the referred to above present fairly, in all material respects, the period ended December 31, 2001. These financial statements financial position of Centene Corporation and subsidiaries are the responsibility of the Company’s management. Our as of December 31, 2001 and 2000, and the results of their responsibility is to express an opinion on these financial operations and their cash flows for each of the three years in statements based on our audits. the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. We conducted our audits in accordance with auditing stan- dards generally accepted in the United States. Those stan- dards require that we plan and perform the audit to obtain reasonable assurance about whether the financial state- ments are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts /S/ ARTHUR ANDERSEN LLP and disclosures in the financial statements. An audit also St. Louis, Missouri includes assessing the accounting principles used and signif- February 1, 2002 icant estimates made by management, as well as evaluating CORPORATE INFORMATION
BOARD OF DIRECTORS FIELD OFFICERS COMMON STOCK INFORMATION Samuel E. Bradt Christopher Bowers Centene common stock is quoted on President, Merganser Corporation President and CEO, the Nasdaq National Market under Superior HealthPlan the symbol “CNTE.” The following Edward L. Cahill table shows the quarterly range of Partner, HLM Management Kathleen R. Crampton high and low sales prices of the com- President and CEO, Robert K. Ditmore mon stock since the Company’s initial MHS Wisconsin Former President and COO, United public offering on December 13, 2001: Healthcare Corp. Rita Johnson-Mills High Low President and CEO, Claire W. Johnson MHS Indiana 2001 Fourth 23.10 14.27 Chairman of the Board, Centene Corporation 2002 First 23.56 18.10 Alexander H. McLean Second 31.09 22.61 Michael F. Neidorff President and CEO, Third 30.67 21.70 President and CEO, Centene Corporation University Health Plans, Inc. Fourth 35.48 25.45 Richard P. Wiederhold Robert J. Nolan President and CEO, DIVIDEND POLICY VP, Regulatory Network Elizabeth A. Brinn Foundation Development and Integration, The Company has not paid any divi- Centene Corporation dends on its common stock, and SENIOR MANAGEMENT expects that its earnings will continue to be retained for use in the operation Michael F. Neidorff OFFICERS President and CEO and expansion of its business. Judy Bauer Joseph P. Drozda, Jr., M.D. VP, Care Management ANNUAL MEETING Sr. VP, Medical Affairs Cynthia P. Jansky The Annual Meeting of Shareholders Carol E. Goldman VP, Human Resources will be held on Monday, May 6, 2003 VP and Chief Administrative Officer James E. Reh at 10:00 a.m. at The Ritz Carlton St. Louis, 100 Carondelet Plaza, Catherine M. Halverson VP, Facilities Management St. Louis, MO 63105 in the Plaza Sr. VP, Business Development Joann Taylor Room, 314-863-6300. VP, Member Affairs Cary D. Hobbs VP, Strategy and Business Implementation TRANSFER AGENT CORPORATE AND Robert C. Packman, M.D. INVESTOR INFORMATION Mellon Investor Services P.O. Box 590 VP, Chief Medical Officer CORPORATE HEADQUARTERS Ridgefield Park, New Jersey 07660 Centene Corporation Daniel R. Paquin 800-227-0291 7711 Carondelet Avenue, Suite 800 Sr. VP, Health Plan Business Group www.melloninvestor.com St. Louis, Missouri 63105 Brian G. Spanel 314-725-4477 Sr. VP and Chief Information Officer www.centene.com John D. Tadich FORM 10-K Sr. VP, Specialty Companies The company has filed an Annual Karey L. Witty Report on Form 10-K for the year Sr. VP and Chief Financial Officer ended December 31, 2002 with the Securities and Exchange Commission. Stockholders may obtain a copy of this report, without charge, by writing: Investor Relations Centene Corporation 7711 Carondelet Avenue, Suite 800 St. Louis, Missouri 63105 Designed by Curran & Connors, Inc. / www.curran-connors.com Designed by Centene Place 7711 Carondelet Avenue Suite 800 St. Louis, MO 63105 P 314-725-4477 F 314-725-5180
WWW.CENTENE.COM